The explosive collapse of crypto exchange FTX has sent shock waves throughout the industry and cost up to a million investors an awful lot of money.
Even if you wouldn’t touch Bitcoin, Ethereum, Dogecoin and all the other alt-coins, you can still learn from them.
Here are 12 investor lessons worth learning after the latest crypto meltdown, which you can apply to your own portfolio.
What is Bitcoin and how did it start?
1. Beware false prophets
Sam Bankman-Fried, the self-styled eccentric genius behind FTX, is a shaggy-haired 30-year-old in shorts and untied trainers, who famously played League of Legends while on business phone calls.
It’s no surprise that crypto fans loved the “unkempt millennial”, as The Wall Street Journal called him, but grown-up investors who should have known better also bought into the “SBF” cult — and paid a high price.
Mr Bankman-Fried has gone from “billionaire prodigal son to bankrupt pariah in record time”, says Matt Weller, global head of research at Forex.com and City Index. “The implosion of FTX has set the crypto industry back tremendously.”
2. Everybody is wise after the event
Just as investors rushed to praise SBF before the crash, now they are rushing to bury him. This is yet another warning of the dangers in following the crowd.
Stick to what you understand. Billionaire investor Warren Buffett is widely quoted, but judging by recent events, widely ignored.
The “Sage of Omaha” famously said: “Invest in what you know … and nothing more.”
Unfortunately, that lesson was lost on the venture capitalists who poured money into FTX, having fallen for the SBF myth.
Huge financial institutions such as BlackRock, the world’s biggest fund manager, also fell for the hype, Mr Weller says.
3. Ignore celebrities
You wouldn't take fashion tips from a crypto investor, so why take investment tips from a celebrity?
Yet, that's exactly what people did with FTX, which was endorsed by A-list celebrities such as NFL quarterback Tom Brady, his ex-wife, model Gisele Bundchen, basketball player Shaquille O’Neal and Seinfield writer Larry David. All skilled in their chosen field, but that wasn’t finance.
They are now being sued for $11 billion in a class-action lawsuit brought by disgruntled investors. With luck, that will make other celebrities think twice about handing out investment advice.
4. Cheap money blows bubbles
Central bank largesse blew bubbles into everything, from equities to bonds, property, art, sports cars, thoroughbred racehorses and cryptocurrencies, says Russ Mould, investment director at online platform AJ Bell.
“It stands to reason that the withdrawal of that cheap cash will pop the selfsame bubbles,” he says.
We live in a different world today as central bankers tighten monetary policies and investors can no longer afford to take the same level of risk.
5. A crash can last longer than people think
Self-styled contrarian investors may be tempted to go shopping for crypto at today's reduced prices, but they should tread carefully as contagion grows, says Carsten Menke, head of next generation research at Julius Baer.
“Genesis Global Capital, another crypto lending platform, also suspended withdrawals, citing ‘unprecedented market turmoil’ after already being affected by the collapse of Three Arrows Capital in June,” Mr Menke says.
This year has also seen the downfall of Luna, broker Voyager and crypto lender Celsius Network.
“Amid mounting contagion and shattered confidence, any kind of recovery becomes much less likely,” says Mr Menke.
“The wounds of this crypto crisis will need much more time to heal and the long-term potential of digital assets has firmly moved out of focus.”
6. Trust matters
Trust may sound like an old-fashioned concept but we are lost without it.
FTX was a household name among retail traders in the often-opaque crypto markets, Mr Weller says.
“Likewise, institutions trusted the exchange as a trustworthy, ethical counterparty in the space. Even US lawmakers had a positive view of SBF from his aggressive lobbying efforts and willingness to explain the nuances of the crypto industry.”
All of this trust has been destroyed, leaving behind massive financial losses and extreme cynicism towards crypto markets.
“If even SBF and FTX were running illegal undercollateralised businesses, who can be trusted?” Mr Weller says.
It will take months if not years for the trauma to heal, he says.
7. Beware people who claim to do good
Mr Bankman-Fried followed a creed called “Effective Altruism”, whose adherents pledge to give away as much of their wealth as they can.
Today, many believe his high-minded claims helped to deflect criticism and scrutiny from how he was making that money in the first place.
global head of research at Forex.com and City Index
8. Don't borrow to invest
Investing money you don't have, known as leveraging, can be a respectable strategy in the right hands but it is always risky.
This is particularly so in the case of FTX, which created its own cryptocurrency, FTT, then used it as collateral to raise loans.
Yet FTT had no actual value, aside from a promise by FTX to buy any tokens for $22.
Leveraging is more dangerous than ever as central bankers tighten monetary policies, says Jim Wood-Smith, market commentator at Hawksmoor Investment Management.
“Money has become more expensive and harder to come by and that makes things very tricky for those who need to borrow to stay solvent.”
It is especially dangerous when your collateral is valueless, Mr Wood-Smith adds.
9. There is a point to regulation
If you buy an unregulated asset like crypto, you are on your own if something goes wrong, says Jack Amy, portfolio analyst at digital wealth manager Moneyfarm.
“FTX clients can’t withdraw their funds from the exchange. In a world with no regulator, it will be difficult to get any recourse on cryptocurrency losses.”
At least if you buy a regulated investment and feel cheated, you have some hope of redress.
Cryptocurrencies — in pictures
-
The crypto market, which includes currencies such as Bitcoin, pictured, has lost $2 trillion of its value in six months. Unsplash -
The price of Ethereum, the second largest cryptocurrency by market size, has fallen by 70 per cent this year. Investors and analysts are watching to see if it will dip below $1,000. Unsplash -
Dogecoin, supported by Elon Musk, is about 90 per cent down from May last year, yet it is outperforming Bitcoin and Ethereum in the current crash. Unsplash -
The government of El Salvador has invested $105 million in Bitcoin. President Nayib Bukele's embrace of the cryptocurrency as legal tender is being questioned as the market crashes. Getty -
Changpeng Zhao, founder of crypto exchange giant Binance, has compared the current market turmoil to the dotcom bubble of the early 2000s. Still, the company is aggressively pursuing licensing in international jurisdictions and introducing new products. Getty -
Tether is the biggest issuer of stablecoins, a type of cryptocurrency pegged to a traditionally stable asset like the US dollar. Most stablecoins are meant to maintain a constant price of $1 and are backed by real reserve funds, making it easy to convert crypto investments into cash. But Tether's financial statements show that may not be true, leaving the issuer and its investors vulnerable. Unsplash -
The recent crypto crash can in part be attributed to the collapse of TerraUSD, a stablecoin pegged to the US dollar through algorithms and linked to a "sister" cryptocurrency named Luna. When the price of Luna plummeted, TerraUSD also fell, creating a “death spiral” to practically zero for both coins. Unsplash -
On June 12 crypto lender Celsius Network said it had paused customer withdrawals, saying it needed “to stabilise liquidity and operations”. Investors are still waiting, with no signs that the current meltdown will let up. Getty
10. Speculating and investing are two different things
Mr Wood-Smith says his portfolios “have never, do not and will not hold” crypto.
“They are not, in any shape or form, investments but sheer speculation.”
As with any speculative venture, do not invest money unless you can afford to lose all of it.
11. There will be another bubble soon enough
There is nothing new about crypto, Mr Wood-Smith says.
“Homo sapiens have rarely been able to resist the lure of speculation. We are deterred by neither history nor experience.”
Tulip bulbs, the South Sea Bubble, dot-com shares, Bernie Madoff and Beanie Babies have all gone the same way, he says — and there will be more.
All have one thing in common: when there is big money to be made, investors lose their heads. Then their shirts.
12. History suggests there will be more bubbles, so how do you spot one?
All bubbles have similarities, says Mr Mould.
“The starting point for a bubble is a new investment opportunity, one that may be genuine, or even one with just a big enough grain of truth to be irresistible to those looking for a quick financial killing.
“It could be anything from railways to cryptocurrencies and the more disruptive or revolutionary it seems, the better.”
That may help you to identify the next one - but it may prove difficult to resist.
