The collapse of FTX and its crypto-asset token, FTT, is a tragic loss for millions of investors. We aren’t going to focus on blame or whether fraud charges might be on the table but rather discuss some of the red flags that existed beforehand and what the fallout could mean in the long run.
First, I want to discuss why I’m writing this and its importance. Many analysts warned about the dangers of unregulated finance and deposits. Since the MTGOX meltdown, some crypto supporters call failures or scams outliers and remain crypto-believers (HODLers). The same is true today.
“The majority of the people in the industry could not have seen this coming because FTX is such as dominant player.”
Vicky Ge Huang, Wall Street Journal Crypto Reporter
Despite claims that the industry was blindsided, all the clues were there, and some brilliant people were warning.
What were the clues savvy investors could look for? Especially those without a background in finance are faced with one question. What is the difference between a scam and a legitimate investment?
Savvy investors ask questions. Here are some examples of questions to ask before giving anyone your money.
Crypto-assets and markets that operate out of compliance with applicable laws and regulations, or are unregulated, can breed fraud, abusive market practices, and disclosure gaps.
U.S. Department of Treasury (2 months earlier).
Do they do what they say?
A big part of integrity is actions that follow your claims. If someone CLAIMS they are outsmarting the market and then ACTS by buying an S&P 500 ETF. There is a mismatch. To outsmart the market, you must do something different than the market by definition. Following crowds is not the same as outsmarting them. The best-case scenario is that the claim was a lie. Lies and dishonesty should be a warning sign.
As a state-registered investment advisor, we work with regulators who review our registration documents and contracts to see that our actions match our claims. Reviewing documents and actions are ways that regulation can help.
Do they ignore the risks?
Here are some standard disclaimers that show up from time to time.
- All investments contain risk. Consult with your professional before making investment decisions.
- Investments are not guaranteed. The value of your investment may go down.
- Past performance is no guarantee of future results.
Scroll down, and you’ll even see some disclaimers on this post. Even “guaranteed” insurance products often have disclaimers:
- Tax consequences are not reflected in this illustration.
- The illustrated benefits and values are not guaranteed.
I use disclaimers for three reasons.
- The regulators make me use disclaimers.
- I don’t want to get sued.
- I do not want to mislead people.
Here is an example of a crypto-believer calling something risk-free:
Neel Achary from Business News This Week falsely claims. “A risk-free crypto trading strategy allows you to profit from the market without losing any money.” If it isn’t clear from the rest of this post, Neel’s statement is a dangerous lie.
- The regulators make me use disclaimers.
The SEC does not generally regulate crypto assets like cryptocurrencies and NFTs. (There are some notable exceptions, such as INX.)
2. I don’t want to get sued.
There are different legal requirements and consumer protections regarding digital assets. Some companies believe they will not be subject to the same scrutiny and are willing to take the risk.
3. I do not want to mislead people.
Many crypto-asset proponents are decent people who don’t want to hurt anyone. I’ve met a few. It only takes one or two bad actors to perpetuate a vast scam. You can’t automatically trust people but meet them with professional skepticism.
How will I get paid back?
Getting paid is the most crucial question. In investing, fundamental analysis is the skill to see if spending money on an investment (like research or new equipment) will be worth it in the long run. (https://www.investopedia.com/terms/f/fundamentalanalysis.asp)
As an example, think about Moderna at the start of the pandemic. Before they had any product, they needed to invest in scientists, manufacturing equipment, lawyers, advertising, testing, and many others. Some investment professionals did the math, they knew that the vaccine might not work, but they determined it was worth the risk anyway. With the benefit of hindsight, they were right and made their money back.
Let’s think of a very different example, a pyramid scheme. You give the founder $2. Then you find ten more investors to provide the founder with $2 each ($20 total). He’ll give you back $5 and keep the rest. You get paid when you find a bigger sucker to buy your investment. The pyramid scheme example isn’t investing but rather a scam.
Crypto-believers say cryptocurrency will replace fiat currency, but let’s walk through an exercise.
Imagine you are the CEO of Walmart. You operate over 10,000 stores in 24 countries. (Source) One day, you decide that it’s hard dealing with currency and want to accept Bitcoin.
First, you will need to develop a way to process the payments. Conservatively, you have 100,000 credit card machines to replace with something that can quickly verify blockchain transactions.
Next, Walmart employs 1.7 million people in the U.S. alone. You need to convince them a crypto wallet is better than the paycheck they get. Your state and federal wage enforcement officers might question how to comply with minimum wage law, given that you don’t use the currency.
Finally, Walmart has a lot of vendors. You need to pay your vendors in cryptocurrency. In 2021, Walmart paid vendors $420 billion. As of 11/15/2022, all the Bitcoin are collectively worth approximately $322 billion. How is that going to work? Is the price of bitcoin going to shoot up to meet Walmart’s needs?
Now that we discussed some (not all) of the challenges, you decide. What is the incentive for you to make this switch? Cyrpto-believers say the U.S. Government is corrupt with the dollar, but as Walmart’s CEO, the U.S. dollar has made you reasonably successful in your life. From your perspective, what would it take to make you change?
Disclaimers (as promised):
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed to be reliable and has reasonable grounds to believe that all factual information herein is true as at the date of this material.
It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice.