TSI #22: The rise and fall of FTX and what we can learn from it
Nov 20, 2022Hello Stoic Investors,
Today I want to focus on how you can make better financial decisions by examining what went wrong with one of the largest cryptocurrency exchanges.
“It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.” – Legendary investor Warren Buffett
That being said, let's look into one of the most recent financial disasters.
What exactly is FTX?
FTX and Binance are cryptocurrency exchanges, meaning they enable customers to trade digital currencies for other digital currencies or traditional money, and vice versa.
Disaster step 1: The background
Before I explain the details of the collapse, I'd like to explain the background a bit.
FTX has a native cryptocurrency token called FTT, which traders use for operations like paying transaction fees. So instead of paying the fees with cash, you're paying them with FTT tokens.
Naturally, FTT tokens have to be rather stable, which is why the token is categorized as a stable coin. Binance held a portion of those tokens as a result of a previous deal with FTX.
On Nov. 2, a leaked document appeared to show that Alameda Research, a hedge fund run by FTX founder Bankman-Fried, held an unusually large amount of FTT tokens. Alameda held billions of dollars worth of FTX’s own cryptocurrency, FTT, and had been using it as collateral in further loans. This meant Bankman-Fried was basically printing money out of thin air.
Naturally, something was bound to go wrong.
Disaster step 2: The cause
Binance announced on Nov. 6 that it would sell its FTT tokens “due to recent revelations.” Its position was thought to be around 5% of the total, worth around $580m before the currency crashed. However, that set off alarm bells among investors.
I'm still not sure whether Binance purposefully brought down the competition. After all, they did have the power to do that.
Disaster step 3: The avalanche
In response to Binance's sale, FTT’s price plummeted and traders rushed to pull out of the FTX exchange, fearful that it would be yet another fallen crypto company.
FTX scrambled to process requests for withdrawals, which amounted to an estimated $6 billion over three days. It did not have that kind of money. Nevertheless, Bankman-Fried still had the courage to tweet: “FTX is fine. Assets are fine.”
Disaster step 4: The rescue
On November 8th, Binance said it had reached an agreement to bail out FTX by buying the company. However, after looking at the balance sheet of the company, Binance backed out.
Disaster step 5: Bankruptcy
Bankman-Fried returned to Twitter to state that he had “fucked up, and should have done better”. FTX filed for Chapter 11 bankruptcy protection on November 11th, in a move that included its US platform and Alameda hedge fund.
In one week, Bankman-Fried's net worth was wiped out. He was last seen travelling to Argentina. Weirdly, at the same time, $600 million was missing from FTX.
What can we learn from that story?
Bankman-Fried's net worth peaked at $26 billion. He lost 94% of that in one day. I can't even image the level of stress. However, most of his net worth was tied in crypto, which is known to be very speculative.
If we look from FTX's perspective, their liquidity was tied to one single token. Imagine putting your company's future into the hands of market sentiment.
In business, you always need to have enough liquid money to pay the bills and survive. The same applies to managing your own money.
So, note down these points and start investing today:
- Crypto is a high risk bet and should be counterbalanced in your portfolio with safer assets
- Always have enough liquidity
- If you do own crypto, make sure most of it is saved on a hardware wallet
