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What the FTX just happened?

What the FTX just happened?

The collapse of the second-largest crypto exchange, FTX, sent shockwaves through crypto markets and stock markets as well.

In August 2022 he was touted as “the second Warren Buffett” by FORTUNE magazine, but Sam Bankman-Fried (SBF) has bankrupted his two companies, with investors losing up to $10 billion, and there are numerous allegations of outright fraud and theft*, not just accidental mismanagement.

The comparison to the world’s greatest investor may be a stretch, as Bankman-Fried made billions from a promise and a dream that lasted less than five years, whereas Buffett has been acing the markets for more than sixty years.

What lessons can investors learn?

The lessons are old-school and have been heard thousands of times, but obviously, many investors need a frequent reminder.

1. Diversification: Many investors faced losses or lockups with the collapse of Celsius earlier this year. Now over a million more investors have lost vast sums due to the bankruptcy of FTX; some claim to have lost their life savings. During the 2008 Global Financial Crisis, there were major banks that went bankrupt. Crypto exchanges are not banks and are not guaranteed. If you have your entire portfolio of cash (or stock, or crypto) stored with one company, you face a massive risk. Investors are prudent to put funds not just into several stocks or cryptocurrencies, but also to have cash savings in several banks.

2. Patience: Buffett started investing at age 10 and became a billionaire when he was 55. Over 95% of Buffett’s wealth was created after he turned 60 years old. Bankman-Fried created billions from thin air and deception, added very little value and was back to broke in less than five years. The adage “easy come, easy go” was first espoused by King Solomon in Proverbs 13:11, and holds true thousands of years later. Savvy investors can still learn a lot from ancient wisdom, whether it be the Book of Proverbs, or The Richest Man in Babylon. Anyone wishing to create true wealth that lasts a lifetime would be wise to learn from the wisdom of those who have already done so.

3. Diversification, yes, again: Sam Bankman-Fried was a schoolboy in short shorts during the terrorist attack of 9/11/2001; Buffett was a seasoned investor with decades of experience. Airline stocks and insurance companies plummeted in value after the plane crash, but Buffett was OK, as he had many different investments. Bankman-Fried had over 90% of his worth in just one coin. When that was hit, he had nothing. Investors, whether in stocks or crypto, should aim to hold a portfolio of 20-40 different investments across various non-linked industries; either managed by yourself or with the aid of a financial professional.

*For those who wish to dive deeply into the schadenfreude, there are numerous stories online about FTX, its sister company Alameda Research, and all the alleged shenanigans that went on. These include, but are not limited to, a $1 Billion “loan” given to the director, paying fake employees, customer funds intermingled with company funds, numerous property purchases made by the company using client funds, with properties being held in the names of employees, and so much more.

And what financial scandal would be complete without allegations of sexual misconduct, polyamory and amphetamine use? Netflix will apparently make a TV series out of this debacle, so stay tuned for “How to Lose A Guy and Ten Billion”.

Another good summary came out on LinkedIn, where the accused was named as “Scam Bankrun-Fraud”. You have to laugh sometimes…

Rumours that FTX was “hacked” after declaring bankruptcy initially had people feeling sorry for SBF. The next story to come out was that SBF hacked his own exchange for $600 million and apparently handed the stolen funds to purportedly corrupt authorities in the Bahamas. It seems that everything SBF touches turns to crime. Personal opinion: we hope that SBF and his cohorts go to prison for a very long time.

All quiet on the crypto front: time to get in?

Both crypto and stock markets are still quite subdued, as there are fears that other companies may have lost large sums in the FTX collapse. These may include BlockFi, Voyager, Galaxy, Apollo and Genesis, among others. Before evidence comes to light, before new companies file for Chapter 11 Bankruptcy Protection, now may be a good time to secure your crypto holdings by moving them off any online exchanges and into a secure wallet.

Whilst fears are high, prices are down, presenting some great buying opportunities. For example, wrapped Bitcoin (WBTC) is trading for a discount. Wrapped Bitcoin can be likened to gold wrapped in silver foil. Bitcoin can only be sent and received on the Bitcoin blockchain, whilst Ethereum can only be sent on the ETH blockchain.

To send BTC on the ETH network, the BTC is “wrapped” in an ETH smart contract so it can be sent via the ETH blockchain. This can be handy if someone wants to run an ETH smart contract, and when the contract is fulfilled, receive payment in Bitcoin.

Fears around the collapse of FTX and Three Arrows Capital have made people sell down their wrapped BTC for less than it is worth. This is similar to fools forgetting that the silver outer layer still contains a full gold bar. Regardless of which company wrapped the Bitcoin, it still contains a full Bitcoin. This fact can be verified on the blockchain, just as any decent jeweller can verify whether your ring is valuable gold or cheap brass.

Never be fooled into paying top dollar for cheap junk; similarly, always buy great value for cheap prices. Brass at gold prices is the playground of scammers. Gold at brass prices is only available when the markets are in panic and fear.

The FTX story will soon blow over (go to jail, SBF, go directly to jail) just as past fiascos have blown over. Nobody cares about Enron, World Com, Lehman Brothers or Theranos anymore. As investors, we still do our homework, do our best to invest into good projects and try to avoid the bad ones. It would be foolish to damn the entire stockmarket because of the 1% of bad operators, and it is foolish to damn all of crypto because of a handful of bad eggs. We should never discard an infant because they have a dirty diaper.

Blockchain was created to create full openness, transparency and build trust. Anyone can look at the code and anyone can see who is holding which cards.

Far from being a failure of blockchain or crypto per se, the FTX story is a tale of human greed, lack of discipline, zero transparency and a complete disregard for how a business is supposed to operate. For those who are yet to understand: a business is expected to pay staff and expenses from its profits; a business is not supposed to use client funds as its own personal play money.

Investors have learned many lessons. It is now time for regulators to call for more stringent controls over who can be trusted to hold client funds, whether they be in crypto, stocks, real estate, funds management or any other business.

Meanwhile: some good news

Meanwhile, in good news, Changpeng Zhao (CZ), CEO of the world’s largest crypto exchange, Binance seems to be the good guy. Initially seeking to buy into FTX, CZ did a little digging (due diligence or DD) and did not like what he found. Aside from FTX mixing company funds with its investors’ funds, CZ saw that the FTX-created FTT token was not subject to “fair launch”. Billions of FTT tokens were held by the company and its directors, meaning that if they sold their FTT, the market would crash.

In a responsible tweet, CZ advised that Binance would be selling all their FTT tokens, with the tacit advice that everyone else should also sell. CZ gave 48 hours’ notice before he started dumping, in a move unheard of in the crypto world, where short sharp surprises and rug-pulls have become commonplace.

FTT tokens predictably went to zero as investors rushed to sell out of the worthless “asset” that was created out of thin air by SBF, a 30-year-old guy who apparently failed Finance 101. As the (allegedly) corrupt felon SBF went from $30 billion to $0, CZ offered up to $2 billion in bailout funds for companies that were affected by the criminal negligence of FTX.

CZ later stated that he wished he could have done more or warned people earlier about FTX. It seems like CZ wants to be more like Buffett: a hero who is in the game for the long-haul. As for SBF, lawyers suggest he could be sentenced to prison “for decades” for massive fraud as well as many other charges. We live in hope that justice will be served, and that regulators will do background checks (or IQ tests) on company directors who think they are smarter than the market.