Cracks In Crypto: What Went Wrong With FTX and Why It Matters
Investors in cryptocurrency are still reeling from the shocking collapse of FTX. The unexpected fall shook the entire cryptocurrency market. It’s as if an earthquake went off in the industry, and what used to be one of the top three biggest cryptocurrency exchanges is now in a free fall, sparking uncertainty in the fate of billions of dollars invested.
As investors in real estate, it’s important to be updated on what’s going on in other asset classes. Cryptocurrency is one that has gained traction in recent years, especially among younger investors. However, when something like the FTX collapse happens, it has ripple effects that have a widespread impact.
If you’re curious as to how FTX has reached this peculiar position, you’re not alone. Below, we’re going to break down what led to this fiasco, and what it means for investors at large.
First things first – what is FTX?
FTX, based in the Bahamas, is a cryptocurrency exchange started by Sam Bankman-Fried back in 2019. It’s a platform that allows its users to purchase, hold, sell, and trade cryptocurrencies. At least they could, before the firm collapsed.
During its reign at the top of cryptocurrency exchanges, FTX used lots of its capital on multiple sponsorship opportunities. This was seen in the Miami Heat basketball team changing their stadium name to “the FTX Arena.” FTX also copped a deal with Mercedes-Benz to sponsor Team SoloMid, a professional esports group, who had the name TSM FTX. These sponsorship deals have obviously been canceled.
But businesses and esports teams weren’t the only ones who bought into the juggernaut success of FTX. Celebrity endorsements elevated FTX’s credibility among investors and society alike. Celebrities like Tom Brady and his wife, Gisele Bündchen, Stephen Curry, and Naomi Osaka also endorsed FTX. FTX even purchased a Super Bowl ad featuring Larry Davis. Now, some of the celebrities who endorsed FTX were named in a class-action lawsuit against the cryptocurrency exchange.
As FTX’s CEO since it was founded up until it filed for bankruptcy, Bankman-Fried recently resigned. Though the company is trying to restructure and survive the storm, there’s a lot that has to go wrong to get to this point.
A Brief History Lesson
As an industry, cryptocurrency has encountered multiple problems throughout 2022. Economic uncertainty and previous exchange collapses in the industry led to other firms falling apart throughout the year. As a result, many cryptocurrency companies filed for bankruptcy this past summer.
So when did FTX get into trouble?
Trouble started brewing for FTX when CoinDesk released a report about Alameda Research, another cryptocurrency-exchange firm owned by Bankman-Fried. The report claimed that Alameda Research was heavily dependent on one of FTX’s tokens, FTT, which accounted for most of the assets on the firm’s balance sheet.
This sparked concern that the two businesses were too entangled with each other, which posed the threat of manipulation or straight up artificial inflation of the value of FTT.
When news got out, the CEO of Binance, another crypto exchange, declared that he was going to sell Binance’s FTT holdings. This resulted in what you might expect - widespread panic. Investors became desperate to take their money out of FTX.
And this led to a good old fashioned “run on the bank.” FTX had more customers asking for their money back than the amount of money they had on reserves. FTT tanked in value, dropping from a peak of $50 per share in March to barely over $1 per share in December.
What Did FTX Do Next?
As you can imagine, FTX did what businesses do when they can’t pay their investors back their money – file for bankruptcy. Bankman-Fried stepped down from his position as CEO the same day both FTX and Alameda Research filed for bankruptcy. This action revealed that the company wasn’t verifying how many of their investors were using the platform, and it didn’t have an accurate record of bank accounts of its users. This is problematic, to say the least.
According to a Wall Street Journal article, former employees at FTX also reported that the company had poor bookkeeping, which led to obscure profits and losses. One former employee claimed on Twitter that she and multiple others left the firm because of concerns they had regarding “risk management and business ethics.”
To break it down: Investors traded their money or other cryptocurrencies for FTT tokens, which went to FTX. A large portion of that money was for some reason sent to Alameda Research, which used it to make high-risk bets. This totaled somewhere between $5-8 billion. This money is currently unaccounted for.
What Did Bankman-Fried Say?
In a recent interview with the Wall Street Journal, when asked what happened to the $5 billion dollars transferred to Almeda Research, Bankman-Fried said that it was, “...wired to Alameda and I can only speculate about what happened after that.”
How Does FTX’s Collapse Impact the Crypto Industry?
Many cryptocurrency investors are concerned. The collapse of an exchange the size of FTX suggests that others can fall too, including Binance or Crypto.com.
This only adds more uncertainty to an already volatile market. Many crypto firms are struggling to pay their creditors, who are looking to withdraw their money after FTX’s collapse. These firms are desperate to avoid filing for bankruptcy.
Some exchanges are offering investors “proof of reserves” in an attempt to provide reassurance that they aren’t using investor money to pay for risky bets. But this doesn’t really guarantee anything, because it only shows how much money these firms have in reserves - not the amount they have in debt to other firms.
What Does This Mean for Real Estate Investors?
This goes to show why it’s so important to invest in real assets. While many investors have made some good money in crypto, there is too much volatility and uncertainty in the crypto market. As argued by a contributor of the Financial Review, buying cryptocurrency is not an investment. It is more similar to gambling. This is because cryptocurrency only has value if “...some other gambler [is] willing to purchase them at a higher price.”
It must be said that blockchain technology is a promising answer to many problems. Blockchain could lead to the decentralization of registering ownership and recording transactions. It can also create and record contracts which can reduce inefficiencies. Society has a lot to gain from these kinds of innovations, but in comparison to real estate, cryptocurrency isn’t a viable investment.
But, there are some advantages of crypto. We’ll explain them briefly.
Pros of Cryptocurrency
Hedge Against Inflation: There is a finite supply of cryptocurrencies like Bitcoin. So unlike dollars, which the government can just print more of, you cannot make more Bitcoin. This means bitcoin is a hedge against inflation. The same goes for real estate - they aren’t making any more land!
Low Barrier To Entry: Investors can buy a portion of a bitcoin. These smaller units are called Satoshis, and are essentially a tiny fraction of a single Bitcoin. As of December 2022, 1 Bitcoin is worth $16,796.40. Ethereum, a popular altcoin, is worth $1,230.30.
Potential Long-Term Gain: In the past 5 years, Bitcoin has increased by 6,000%. Other coins have reported 1,000% returns over the past few years.
Cons of Cryptocurrency
Not Tangible: Cryptocurrency is not a tangible asset. It exists on the internet. This means you could be vulnerable to cyberattacks, and it can be confusing to know the exact value of your coins. This can lead to coins being traded for more than they are really worth, and the lack of transparency in the industry has many investors speculating that crypto is in a bubble. Or, it can leave you with worthless tokens, like what happened with FTT token investors after the collapse of FTX.
With commercial real estate, the value of a property is determined based on how much profit the property produces. This is a factor that is easy to determine, and isn’t as obscure as the value of crypto.
No Cash Flow: Cryptocurrencies do not put passive income in your pocket. The only way you make money with crypto is through capital appreciation ( essentially speculation, or gambling, as I like to call it). Investors assume that the coin will increase in value over time.
Real estate is an asset that produces cash flow, and passive income. Even if the economy takes a dip, real estate can still cash flow.
High Volatility: The value of crypto can change within the span of a few hours, or minutes.
As seen in the chart below, the value of Bitcoin since 2013 has been anything but stable. Being invested in crypto might be a good play if you’re willing to ride out the emotional rollercoaster. But when it comes to parking large percentages of your wealth in such a volatile market, one might think twice before putting it in something like crypto.
Government Regulation: Cryptocurrency trading and use is currently unregulated. This isn’t likely to continue, especially as it becomes more mainstream and after the collapse of FTX. While it’s unlikely the IRS will find a way to control crypto, if the government does pass some regulations on the crypto market, this is going to have an impact on the value of cryptocurrencies at large. For example, in China, after they banned crypto trading, the market crashed.
In the aftermath of the FTX collapse, it’s more clear now more than ever why it’s important to invest in assets like real estate, which have a historical track record, and have been a reliable way for countless investors to build and preserve wealth.
When it comes to achieving financial and time freedom, and building a life by design, don’t gamble with your future by overinvesting in something that lacks transparency and changes as much as fashion or social media trends.