Crypto Bubble

FAN YU is an expert in finance and economics and has contributed analyses on China’s economy since 2015. Fan Yu

FTX Collapse Offers Lessons

Investors should only put their money into things they understand

The cryptocurrency industry is imploding at a shocking rate.

FTX, which a few weeks ago was considered a “lender of last resort” and a crypto industry stalwart, filed for bankruptcy. Its charismatic founder and (former) CEO, Sam Bankman-Fried, lost a $16 billion fortune in a matter of days. Bankman-Fried, who a few months ago was compared to John Piermont Morgan and Warren Buffett, is turning out to be an inexperienced operator at best, and a fraud at worst.

We won’t rehash the events that led up to FTX’s bankruptcy and collapse. Suffice it to say, the speed of its demise has caught industry leaders, regulators, and investors off guard. FTX’s customers are bracing for the worst. Customers of other crypto platforms that FTX previously bailed out—such as Voyager—also are bracing for the worst.

There are several important lessons for investors here, regardless of whether one owns any crypto.

We have to ascribe some indirect blame to the Federal Reserve and the U.S. monetary policy of the past decade. The artificially low interest rate policy in the United States and other nations created excess liquidity—in other words, people had too much money. This created huge asset bubbles that boosted all sorts of asset classes. When everything is going up, and going up fast, very little due diligence is done. This begets more risk-taking, since there’s no incentive to build proper governance and controls when assets are appreciating and nobody is asking questions.

The first lesson is that having bluechip backers doesn’t guarantee success. FTX and Bankman-Fried’s trading firm, Alameda Research, certainly has an A-list of venture capital backers on its cap table. Sequoia Capital, Tiger Global Management, Iconiq Capital, SoftBank, Lightspeed Venture Partners, “Shark Tank” personality and investor Kevin O’Leary, and Singapore’s sovereign wealth fund Temasek Holdings were just a few of the reputable venture capitalists who invested more than $2 billion into Bankman-Fried’s company.

While venture capitalists have funded many success stories, for each Google there are hundreds of failures. FTX— which was valued at more than $30 billion at its peak—is a huge one, of course. But it won’t be the last. Webvan, Jawbone, Houseparty, and Beequick were just a few failed startups funded by Sequoia. Katerra and WeWork were once high-flying SoftBank-backed startups.

FTX’s marketing and partnership efforts made it a household name. But a huge marketing budget also doesn’t correlate with success. FTX ambassadors include NFL quarterback Tom Brady, NBA star Stephen Curry, and tennis star Naomi Osaka. It sponsors Major League Baseball and the Mercedes-AMG Petronas Formula 1 team. The company also had been the naming sponsor of FTX Arena, the home of the NBA’s Miami Heat, although Miami-Dade County and the team have terminated their business relationship with FTX and are seeking a new naming-rights partner.

The firm’s ubiquity could lull customers and prospective customers into a false sense of security. But in investing, there’s no “safety in numbers.” It just means there are more victims.

Speaking of numbers, investors should limit speculation to less than 10 percent of one’s investable assets. There are news reports that some investors had put their “life savings” into crypto and fintech platforms such as FTX, Celsius, and Voyager. There’s no reason that should be the case. Even if an investment doesn’t work out—and many do fail—keeping speculative assets to a trivial amount is good risk management.

Another lesson is investors should only invest in what they can understand. If one cannot explain how a product works or a company operates, be very careful before investing. There are a lot of crypto tokens that sound interesting and are promoted by celebrities or social media influencers but have very shaky business models or utility. Be vigilant.

This brings us to regulation. Overregulation stifles innovation and investment, but a minimum level of regulation is desired for any industry. Not everyone can fully explain and understand the intricacies of an investment or company, and that’s where regulatory agencies can play a key role in establishing reasonable boundaries and frameworks for businesses to operate. Individual investors can’t always perform the level of due diligence to suss out unethical business practices or uncover intercompany conflicts of interest. That’s a role regulators should play.

Coinbase founder and CEO Brian Armstrong put it succinctly in an op-ed on CNBC: “Crypto markets need regulation to avoid more washouts like FTX.”

We have to ascribe some indirect blame to the Federal Reserve and the U.S. monetary policy of the past decade.