Lessons From the Fall of FTX (crypto)

Another week and it seems almost guaranteed that another fraud, failure, or disaster will emerge in the cryptocurrency world. The latest is the bankruptcy of FTX, a cryptocurrency exchange and trading business founded by Sam Bankman-Fried (SBF for short) and said to be the second or third largest in the space, depending on who you listen to. At last count, the $32 billion FTX was valued at, based on the last time it raised capital from investors (it was privately held) has gone up in smoke. Then there’s an apparent $10 billion in customer assets or deposits on FTX, with potentially $8 billion needed to make them whole.

What went wrong? There are many and varied allegations flying around. Fraud, theft, Ponzi scheme, massive money laundering operation. FTX also had a sister hedge fund called Alameda Research and the links between the pair are important.

For FTX’s part, some of the excuses provided are laughable. Bankman-Fried said in a tweet “poor internal labeling of bank-related accounts meant that I was substantially off on my sense of users’ margin. I thought it was way lower.”

Some have taken this to mean that the $10 billion in customer assets at FTX were allegedly mingled with the hedge fund’s trading assets. In other words, FTX was using their customers’ money to trade, trying to sneak some extra profits for themselves. FTX had its own cryptocurrency called FTT. It’s suggested that after FTT was created Alameda Research bought FTT at a low price, it was $1.70 back in 2019, then FTX pumped it up. FTT hit a high of $77 in September 2021, Alameda then used FTT as collateral to then borrow the customer assets from FTX for trading.

Changpeng Zhao, the owner of Binance, the largest cryptocurrency exchange, was a large holder of FTT because at one point he owned 20% of FTX. Bankman-Fried eventually bought Zhao out for over $2 billion, but Zhao was partially paid in the FTT cryptocurrency. Earlier this month Zhao started selling the FTT cryptocurrency. This panicked people.

Of course, when playing such unethical and criminal games, if things turn ugly and losses are incurred, or there’s some clouds around the business and customers suddenly want their money back, the business won’t have the funds on hand to honour redemptions. It’s akin to a bank run and it blows up the business. The fault is always squarely at the feet of the business. In point 8.2.6 of FTX’s legal terms, it was spelled out explicitly that customer money would remain with the customer, and it would not be used by FTX Trading.

Bankman-Fried’s excuse of “a poor internal labeling of bank-related accounts” is disgusting and shameful, but if you step back for a second you get another sense of how ridiculous this all is.

An exchange creates a fake currency, inflates the value, so their related entity, who owns it, can then pledge it as collateral back to the exchange and use other peoples’ fake currencies that sit on that exchange, to trade with, but the value of the first fake currency falls, panicking the owners of all the other fake currencies that sit on the exchange, they demand their fake currencies back, but the exchange can’t give the fake currencies back because the value of the fake currency they created has fallen so much and all the fake currencies held on the exchange are wiped out.

We think that’s a close approximation of what happened, but it’s likely infinitely more complex and that’s exactly why it was so dangerous. In saying that, the specifics will be for the investigators, but they won’t root out the real issue: none of these cryptocurrencies have any underlying value beyond hope and belief. At this point, it’s the only logical viewpoint and precisely why there is now panic spreading throughout the space as other exchanges file for bankruptcy. Sooner or later the majority of coins will likely all be worthless.

Somewhere along the line people thought these new platforms would become the new banks and investors could earn an income on their fake currencies!

The only value any of these platforms or coins have will be the hard lessons they provide.

Here’s a few simple ones.

The media are not a research house. Media coverage is coveted in finance is because investors don’t do their research or don’t know how, but they still want to invest. Media coverage is often wrongly viewed by investors as the reporter having done due diligence. Surely, the media wouldn’t profile a person if they were shady? Wrong! Often, reporters don’t know or don’t care.

As short seller Mark Cohodes noted:

I was onto SBF for many months. It just did not add up. I have been around the fraud business for decades, and this guy ticked all the boxes. I handed the story to the head of the Bloomberg Crypto team in London, which consists of 5 people. They all passed on it because they thought it was too hard, too complicated, and might interfere with gaining access to SBF going forward.

A damning indictment if true.

The most judicious aren’t immune to stupidity. FTX ensnared Temasek: Singapore’s sovereign wealth fund, the Ontario Teachers’ Pension Plan, SoftBank and some other well-known names in the investment world. They all sunk money into FTX throughout various private equity funding rounds.

Ontario Teachers’ Pension Plan chief executive Jo Taylor told Reuters in mid-September that the FTX investment was, “In terms of the risk profile, probably the lowest risk profile you can have in that it’s everybody else is trading on your platform.”

He said the investment was part of Teachers’ strategy to learn about the crypto business and whether it gives the right balance of risks and returns. “I don’t think we have the answer to that question yet,” Mr. Taylor said.

They have the answer now.

Beware virtue signaling. Much was made of Bankman-Fried’s plans to give away all his money. The big focus on effective altruism. The story that he drove a Toyota Corolla. The fact he dressed like a 10-year-old and didn’t seem to comb his hair. All these things played into the idea he was an outsider who didn’t care about money. It’s all a great story, but likely nonsense he used for publicity. Billionaire drives a Lamborghini is boring, billionaire drives a Corolla seems interesting. He owned luxury apartments and apparently had other expensive cars beyond the famed Corolla that the media focused on.

Celebrity endorsements. The track record of fraud or failure when a celebrity or sportsperson is spruiking an investment is astonishing. It’s almost akin to a guarantee that investors will lose money. NFL star Tom Brady, and his now ex-wife, Gisele Bündchen, pushed FTX and were also investors, current and former basketball players Steph Curry & Shaquille O’Neal, tennis player Naomi Osaka and actor Larry David were in ads or ambassadors. FTX also spent a huge amount of money on advertising during the Superbowl and taking the naming rights to the Miami Heat’s arena. Hype is usually covering for something.

Does the income make sense? No matter the asset, if you can’t figure out where the yield is coming from, you might be the yield. With shares, bonds, real estate, and cash it makes sense that they pay income and if they don’t, then it’s likely growth being provided. Cryptocurrency-paying income makes no sense. In other words, it’s probably your new money paying older investors and newer investors are paying you.

The final word goes to a pair of ninetysomethings who knew cryptocurrency was no good from the very start. One diplomatic, one less so.

This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation, and individual needs. #investing #goals-based advice #investments #retirement #retirement planning #smsf #wealth creation #personal insurance #superannuation #martincossettini #fiduciary financial advisor #bluediamondfinancia

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