What’s this FTX Thing Anyway and Should I Be Worried?
Hello! It’s Bradley, Marci’s eldest here again (with some light editing from my mom) hoping to shed some light on what FTX is, why it is collapsing, and what that means for your portfolio (spoiler alert, hopefully, not much).
First things first, what is FTX? FTX is (was) a cryptocurrency exchange. This is, very simply, a place where people can buy and sell cryptocurrency (for more on what cryptocurrency is, see the February 28th, 2021 Bernie’s Blog post about Bitcoin). It works similarly to how our Ameritrade/Schwab accounts work. An investor puts money into an account there, and then buys and sells Bitcoin, or other cryptocurrencies (including FTT, the cryptocurrency started by FTX), just as we buy and sell other securities in our Ameritrade and Schwab accounts.
Now, what happened? Like brokerage accounts and banks, FTX did not actually hold all of its deposits in cash. There’s nothing necessarily wrong with this; we all know that banks make loans with much of their deposits (they are required to hold approximately 10% of their deposits as reserves at any given point in time to accommodate customer’s withdrawals), and Ameritrade does similarly with money in money market accounts. However, unlike banks or brokerages, FTX held its reserves in its own cryptocurrency FTT and had lent much of its customer’s deposits to its sister trading company Alameda Research. Because cryptocurrencies are highly volatile, this means that the value of its reserves could very rapidly diminish. And diminish they did, as the value of FTT has plummeted this year along with most other cryptocurrencies. When customers of FTX heard that FTX was in trouble, many tried to withdraw their deposits at the same time, leading to an old-fashioned bank run. This caused FTX to have to declare bankruptcy, which is where we are now.
What caused FTX’s downfall? Several things:
The CEO of FTX, Sam Bankman-Fried was less than transparent to his customers about the risks of trading cryptocurrency and then used his customers’ money to fund his other businesses. This is against the law, and he could be looking at significant consequences if found guilty.
Cryptocurrency is highly volatile, and essentially unregulated. Unlike stocks and bonds, it has no inherent value, and cryptocurrency exchanges are not protected by the same regulations that banks are. (For example, bank deposits are insured by the FDIC, protecting against bank runs).
How does this affect you, and what can we learn from this? Marci here..
Because we do not recommend cryptocurrency for clients, any direct impact of FTX’s collapse should be very small. As of yet, cryptocurrency is quite separate from traditional stock and bond markets, so any spillover should be insignificant.
LFS is a fiduciary which means that we are legally obligated to act in your best interests. That includes only recommending investments that are appropriate to your particular situation and which we can explain to you (including the risks).
As always, if an investment idea sounds too good to be true, it very likely is.