By Steve Tepper, CFP®, MBA
If one of the young’uns here at Northstar explains crypto to me, really slowly, I get it … kind of … for a day or two. So when I title this article “For Dummies,” I don’t just mean you, if you are unsophisticated about this giant market sector. I’m talking about the author as well!
The first thing to understand about trading cryptocurrencies is you’re not doing it through your regular brokerage account at TD Ameritrade or Schwab. You are opening an account, usually through an app on your phone, with a trading exchange such as TradeStation or Robinhood. Depending on how or where those exchanges are set up, there may be way less regulation than on your standard brokers and banks.
What could go wrong?
Well, what could go wrong or, more accurately, everything that could go wrong went wrong last month, as one of the largest crypto exchanges went from tens of billions in assets to zero in a matter of days.
This is the abridged, as best as a 59-year-old can understand it, story of the fall of FTX and its enigmatic and charismatic founder, 30-year-old Sam Bankman-Fried. SBF, as he is called, also had close ties to a crypto hedge fund called Alameda Research, which was run by his ex-girlfriend, the not-quite-as-charismatic, 28-year-old Caroline Ellison.
In addition to trading Bitcoin, Ethereum, and all the other well-known cryptocurrencies, you could also buy FTX’s own token, cleverly named FTX Token.
Except there was no such thing as FTX Token. The money that was invested in it was heavily leveraged and used as collateral to borrow billions of dollars to buy a bunch of other companies. SBF also funneled billions over to Alameda, as gigantic losses started to mount on Ellison’s reckless, unhedged trades.
But the money invested in other, real tokens—that was OK, right? Nope. Despite investors believing they owned, collectively, billions of dollars of bitcoin, the amount FTX actually invested in it appears to be a big goose egg.
Some people started to get suspicious, and a social media blitz prompted a large number of investors to try to pull their money out at the same time, resulting in a “bank run”-type situation that collapsed the company and exposed the massive fraud. Investors opened their apps and found their account balance was $0.00.
Regulation in the crypto space has not yet caught up to the explosive growth and risk in the sector. Making it even more difficult, FTX was incorporated offshore, in Antigua and Barbuda, and headquartered in the Bahamas, allowing them to avoid even the little regulation we have in the U.S. That also meant investors had no FDIC or SIPC insurance as they would on U.S.-based banks and brokerage accounts.
We will definitely be learning more as this story unfolds, and look forward to many years of books, documentaries, and movies to come.
Bottom line: Investing with a phone app in an unregulated company in the Caribbean may seem “paradigm shattering” to some investors (or to be more accurate, some former investors). You may be called a dinosaur for resisting or dismissing it. If that’s the case, call me T. rex!