What We Can Learn from the Bankruptcy of the FTX Crypto Exchange

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Did you see the headline about the crypto exchange, FTX filing for bankruptcy protection on Friday? You may not own a dime of cryptocurrency, but I think this story has implications for all of us. Just to give you a quick overview, FTX was an exchange, or a marketplace in which cryptocurrency was bought or sold. Many people also used the exchange to hold custody of their crypto assets. Side note: whether you have cash or crypto assets, you have to store it somewhere, and many of FTX’s customers stored it with that company and they assumed these assets would be safe. Now the greatest fear for any custodian of assets is a so called “run on the bank.” This is when a large number of people all want to cash out at the same time. If a large number of these requests come all at once a company may have to sell some of its assets to meet those redemptions. This is what happened to FTX. The details are murky, but apparently after a Coindesk report providing an in-depth look into the balance sheet of FTX, certain investors got spooked and wanted to withdraw their assets. Allegedly, in the process of redemptions, FTX loaned its clients funds to a sister business to help cover that company’s redemptions without the client’s permission. In other words, clients thought their assets were held in custody separately and that they would not be mingled with FTX’s operating assets nor with any of their sister businesses. So the end result is that the owner of FTX saw his net worth go from $16b+ dollars to nothing within about a week’s time, and several high profile investors and advocates of the company have their money locked up as inaccessible and may even be facing a loss of the money all together. This was a jaw dropping set of events in an extremely short amount of time and again, it has implications for us as we try to make financial decisions. Here are a few takeaways:

1. Know who you are doing business with. In the digital age, we are often doing business with so many counterparties that we really aren’t sure who we are really dealing with. The more money you are considering spending or investing, the more due diligence you should do to make sure you understand who is really on the other side of the transaction – or in this case, who is handling the money on your behalf. Ask questions. Do your homework. The more money at stake, the more time you need to take to do this. Now doing your homework doesn’t mean that you’ll be immune to fraud and knowing the people you are doing business with doesn’t guarantee that they will be trustworthy. But taking this approach does give you a better chance of having that outcome that you expect from the people you do business with. Do business with people who have earned trust, particular over years and years of serving people faithfully. “Buyer Beware” is a phrase that would serve you well. Ronald Reagan used another phrase that sums this up well – trust, but verify. This keeps everyone accountable and gives you a better chance of getting what you expect.

2. There are risks to putting money to work in the Wild West. When I say Wild west, I am referring to asset classes that are in their infancy and that are unregulated. Some are attracted to these asset classes for that very reason. They don’t like regulation and want to invest in things that are free from government involvement. Well, there are tradeoffs that come with this. These newer asset classes have not been observed in a host of different economic cycles and have not had the opportunity to stand the test of time. It’s true, some people have made big money investing in crypto currency. Others have lost nearly everything they own. It all depends on where you got in. So anytime you are considering putting money into something new, don’t just focus on the potential reward, but also identify the risks that accompany these rewards. In most instances, the greater reward that is at play, the greater risk one will take in pursing it. And when making money in risky assets seem to be as easy as shooting fish in a barrel – beware. A reckoning is coming somewhere down the line. It may take time – but easy money eventually leads to irrational risk taking – which then leads to a loss of money.

3. Borrowing comes at a cost. Interest rates have been so low for so long, that many have forgotten what risk is. When you can get money cheap, it’s easy to throw it into anything and everything that promises a good return. But as interest rates start to rise, businesses with lots of debt feel the pinch of higher borrowing costs, and this can lead to stress on the company. Borrowing money is always riskier than using your own. Don’t let anyone tell you differently. Yes, it can be good to use someone else’s money to make money, but there is a cost to doing so – not only in interest paid, but in additional risk assumed. People call borrowed money leverage in good times, but they call it shackles in bad times. So, keep your borrowing at a minimum and when you do borrow, try to tie it to revenue producing activities rather than lifestyle enhancing ones.

4. This high-profile bankruptcy won’t be the last. Warren Buffet likes to say that when the tide rolls out, you discover who has been swimming naked. With the fastest rise in interest rates in 40 years, we are about to see who has been swimming naked. There will be more big names that will fail that may surprise you. So before we begin to see additional dominos fall, before we find ourselves in a moderate recession, take stock of the risks you are taking and reduce them where you can. Better to make changes while times are still relatively good than to be forced to make those changes when times aren’t.

At MBC\Foundation Bank, we’ve been helping people manage their money for nearly 90 years. We’ve tried to build trust and loyalty one transaction at a time and one client at a time. We love to have the opportunity to do that with you. Start your financial conversation today by visiting our website at foundationbank.org. If you’ve found this podcast helpful, we hope that you will subscribe to it in your favorite podcast app and share it with your friends on social media. Please remember that this does not constitute a recommendation specific to your own unique circumstances. You’ll need to consult your own advisors for your situation. MBC and Foundation Bank are a member FDIC and equal housing lender, and until our next Podcast, God bless you. -President Chad P. Wilson, CFP

Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of McKenzie Banking Company / Foundation Bank on November 15, 2022. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.