On November 11th, 2022, cryptocurrency exchange and fintech unicorn FTX filed for bankruptcy. In an instant, a 32-billion-dollar valuation in the portfolios of many of the world’s most pre-eminent venture capitalist firms was marked down to pennies. In this piece we will explore just what happened at FTX, the null impact of these events on investors with Altafid, and the importance of diversification in mitigating the impact of black swan events like this on your portfolio.
What happened at FTX?
The situation is complicated, but the general timeline goes something like this:
- 2019: FTX, a cryptocurrency exchange, is launched by Sam Bankman-Fried (SBF), garnering the interest of the who’s who in the fintech VC space. In just three years, FTX grows from concept to fintech unicorn, with a $32 billion valuation. Along the way, FTX develops a native token, FTT, to facilitate transactions within the FTX exchange.
- November 2, 2022: reports by CoinDesk showed that a quantitative trading firm owned by SBF, Alameda Research, held a position of $5 billion FTT, raising questions about SBF’s liquidity.
- November 6, 2022: Binance, a competitor in the cryptocurrency exchange space, announced that it would liquidate its $529 million position in FTT in the short term, raising fears of a liquidity crisis and even insolvency at FTX.
- November 7, 2022: Despite efforts by SBF to quell investors’ fears, clients demand $6 billion withdrawals from FTX within hours; the value of FTT plummets 80% in just two days (see figures).
- November 8, 2022: Binance announces a plan to buy the non-US portion of FTX’s business.
- November 9, 2022: Binance backs out of the previously announced deal, citing concerns over FTX’s mishandling of customer funds
- November 10, 2022: SBF admits, on Twitter, that FTX does not have sufficient funds to meet customer liquidity needs. Investigations by multiple jurisdictions are launched into FTX’s handling of customer funds.
In the coming weeks, months, and years, there is likely to be more information on the internal compliance dynamics at FTX that allowed this to happen, and there will almost certainly be federal investigations. Many are pointing to these events as a case study for why there is such strict regulation in the markets for securities and in the banking industry. These standards do not apply to the crypto industry. Every investor should be aware of this important difference.
Why doesn't this affect Altafid clients?
In short, outside of clients who might have investments in the venture capital firms backing FTX, or those who had deposits with FTX, or those with exposure to FTT, the FTX platform token, most global investors will dodge the consequences of this scandal and the upcoming bankruptcy proceedings. Within this group of investors, who have no reason to worry whatsoever, are Altafid's clients.
Relative to traditional financial markets, cryptocurrencies and crypto exchanges have much looser (if any) regulation. For investors with Altafid, client assets are stored with highly regulated custodian banks to ensure money is safeguarded. For example, each custodian working with Altafid is a member of SIPC, a federally mandated non-profit organization that protects customers for up to $500,000 of assets. Further, Altafid cannot transfer clients' funds to a related company as FTX allegedly did with Alameda. Nor can Altafid use clients' assets as collateral to take leveraged positions in any asset, as FTX allegedly did with their customers' money. Investors with Altafid should rest assured knowing that the company does everything we can to safeguard client assets from these types of situations, strictly adhering to current regulations and relying on custodian banks of recognized stature and experience.
What lessons can investors learn from this situation?
The most salient lesson investors can learn from the FTX situation is the importance of diversification when building portfolios. Venture capitalists are often held up as some of the very best investors, able to combine financial acumen with long-term thematic vision. The who’s who of VC investors, ones who previously hit big pay days on companies like Facebook, Uber, etc., invested significantly in FTX. None of their prior knowledge or investment acumen allowed them to see this coming. However, these funds did not invest only in FTX, since they know very well that these emerging companies are highly risky. Hence, even if they write down their FTX investment to zero, their overall portfolio could still remain strong. This serves as a lesson for retail investors, who sometimes prefer to bet almost everything on just a few companies.
Events like those surrounding the downfall of FTX underscore the importance of one of the most basic tenants of investing: diversification. Through diversification, investors ‘spread their bets’ across many companies, instead of concentrating in a select few. This, in effect, means that a well-diversified portfolio eliminates idiosyncratic (or company specific) risk, reducing the effects of any single company’s performance on the overall performance of the portfolio. In pursuing a successful investment experience, diversification is one of the most useful tools investors have to manage risk and maximize their probabilities of success.
Disclosures
This material is for informational purposes and is intended to be used for educational and illustrative purposes only. It is not designed to cover every aspect of the relevant markets and is not intended to be used as a general guide to investing or as a source of any specific investment recommendation. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. This material does not constitute investment advice, nor is it a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. In preparing this material we have relied upon data supplied to us by third parties. The information has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made by Altafid, PBC or its affiliates, as to its accuracy, completeness or correctness. Altafid, PBC or its affiliates do not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regard to the results obtained from its use. Altafid, PBC or its affiliates have no obligations to update any such information.
