Over the past week, Cryptocurrency has been in the news and it hasn’t been good. At Cassady Schiller Wealth Management, cryptocurrency has been an area that we’ve received inquiries about many times and have investigated. The challenges that we always came back to was a lack of regulation, extreme volatility, uncertain future. This article is meant to serve as background information on the recent events and serve as a cautionary tale for those investing in cryptocurrency or considering it.
This week, a major cryptocurrency exchange called FTX went from a valuation of roughly $32 billion[i] to bankruptcy in a matter of days. This was no small-time business. In fact, they held the naming rights to the Miami Heat’s arena, and attracted millions from investors the likes of Tom Brady and Gisele Bündchen, Blackrock, and even some teachers’ pensions.
So, what happened!?
To illustrate this, we’ll compare FTX to a bank. With a bank, they take in deposits, and use those deposits to then loan out for various needs – business loans, mortgages, etc. Through evolving regulations, banks have capital controls and reserves that they must maintain in order to meet withdrawals. Ultimately, should a bank go under, deposits up to $250,000/ person are insured by the Federal Deposit Insurance Corporation (“FDIC”). Effectively, the system is built on trust and confidence in the institution that your money will be there for you. The government has a vested interest in that trust and goes to great lengths to continually evolve regulations that foster confidence.
In the case of FTX, they were operating in a similar fashion to a bank. They were using deposits to invest in other business and cryptocurrencies. Recent volatility in the cryptocurrency market led to their investments to drop rapidly. On Sunday 11/6/2022, FTX began to see what we would equate to a bank run, as depositors began pulling their cryptocurrency in mass from the exchange. This led to them halting withdrawals from the platform and by Friday, 11/11/2022, FTX officially declared bankruptcy.
What is to come for those that had deposits with FTX is largely unknown at this time. It will be litigated and politicized for months and is sure to re-invigorated the conversation around regulation in the space. Admittedly, as advisors and fiduciaries, the cryptocurrency world seemed like a mirage. Massive returns and instant wealth creation! We’re being reminded once again, that it’s never that easy. However, we believe this will have a silver lining to it. With a bigger spotlight on the industry, regulations should help to better legitimize the industry and hopefully that will evolve into a foundation of trust and confidence that clients require of financial institutions. In the meantime, if you are (or prospectively) involved with cryptocurrency, consider the institution that you are investing with, not just the coin or token you are holding. As we’ve witnessed, that decision could carry more risk than the coin/token itself.
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