by David Koff & Michael Joseph Fox
Many of you asked me — both publically and privately — to write about the topic of cryptocurrency in 2022. My staff and I (there are two of us now!) spent a fair amount of time trying to meet that request: we wrote about how cryptocurrencies work, about what NFTs are and how they function, about who created Bitcoin, and more.
For some of you, these articles were helpful. They were for me as well. I didn’t know all of the details about the cryptocurrency world that I shared with you until I put in scores of hours of research. Learning about the topic in far greater detail was powerful, fascinating, and - at times - a bit odd. Digital currency?!?! Buying and selling digital collectibles that are worth hundreds of thousands of dollars?
Wow.
For others, my articles created, perhaps, a false sense of security. I heard from one of my readers — one of my oldest and dearest friends, in fact — who shared that he feared that I’d made the topic sound too attractive to my readers. He cautioned that I’d not done enough to help educate subscribers about the risks that are associated with cryptocurrencies.
Now, this is someone I love, so I took his feedback seriously. For my part, I went back to re-read what I wrote, and thought we were clear on both the rewards AND risks of investing in cryptocurrencies and NFTs, but…
I ultimately agreed with him. I thought I could do better. So, at the end of last year, I decided to write an article that was more of a cautionary tale. I began to earnestly research and outline such a piece. And then…
The Fall of FTX
As 2022 came to an end, the cryptocurrency market hit the news. Hard. For that, you can thank a fella named Sam Bankman-Fried. Mr. Bankman-Fried founded and ran a company called FTX, a cryptocurrency trading platform that used to be one of the largest in the world.
Used to be.
That company is now bankrupt and Bankman-Fried was hauled before Congress to testify about his company’s shocking lack of transparency to his users, investors, and creditors. The news that one story generated - and the hubris of the man at the center of that tale - is where we’ll begin today.
The collapse of the company was so nasty that the company hired the man who came in to clean up the Enron scandal, John Jay Ray, III. And that fella - a professional executive who has helped clean up the worst crimes that corporate America used to hurt innocent consumers - didn’t mince words about FTX in the company’s bankruptcy filing:
“I have over 40 years of legal and restructuring experience. I have been the Chief Restructuring Officer or Chief Executive Officer in several of the largest corporate failures in history. I have supervised situations involving allegations of criminal activity and malfeasance (Enron). I have supervised situations involving novel financial structures (Enron and Residential Capital) and cross-border asset recovery and maximization (Nortel and Overseas Shipholding). Nearly every situation in which I have been involved has been characterized by defects of some sort in internal controls, regulatory compliance, human resources and systems integrity. Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”
Whoa.
The collapse of FTX created an ugly domino effect: the BlockFi trading platform declared bankruptcy; many thousands of FTX consumers who are everyday people have - most likely - lost all of their savings; experts speculate that $1-2 billion of consumer money has been lost; and the man responsible for this epic collapse - Sam Bankman-Fried - secretly transferred $10 billion of his customers’ funds away from FTX to help keep his own trading firm afloat financially.
This was, to put it lightly, perhaps the most ghastly theft of the public’s trust and money by a corporation in global history.
Underpinning this shocking news is a concept that all of us know but sometimes prefer to not remember: all investments - all of them - are risky.
Whether you invest in a stock, an index fund, a tangible commodity like gold or other precious metals, or a digital commodity like NFTs and cryptocurrencies, every investment has risks. Your investment might grow or shrink depending on a variety of factors. These include how the markets behave which, in turn, are greatly influenced by global events, news, trust, supply and demand, and - as should now be very clear - people’s ethics, morals, and principles.
Not all CEOs are moral. Not all will honor the public trust.
And, in the case of digital money and collectibles, the risks are far greater than other investments. Here’s why…
The Risks of Crypto
No Bank Backing
The biggest reason why cryptocurrencies and NFTs are far risker investments is that they have no backing from any government or central bank. This means, unfortunately, there are no parties who are ultimately responsible for helping to maintain those assets’ stability. Instead, investors are left at the whim of the market.
That’s a massive problem when the market tanks.
By comparison, national currencies like the US Dollar or the British Pound have the backing of national banks. This means that a government that issues its own currency is then responsible for backing that currency and working to ensure that it remains as stable as possible. For example, The United States Federal Reserve acts as our central bank and backs the American dollar. Their support and efforts to manage the dollar have helped ensure that it remains a powerful currency in international banking.
Lack of FDIC Insurance
The second largest problem with cryptocurrencies is that they aren’t insured by the Federal Deposit Insurance Corporation or “FDIC”. As a result, investors are left helpless if their investments fail due to a severe lack of ethics or morals by the people running digital financial exchanges.
The FDIC states that people who have money in any FDIC bank automatically have their funds insured at up to $250,000 per person. Got $250,000 in an FDIC-insured bank? Then your funds are guaranteed and backed by the US government, even if the bank fails or declares bankruptcy. This insurance is free, by the way.
If you think it’s unusual for a bank in the US to fail, think again: since 2000, over 550 banks have failed, prompting the FDIC to swoop in and save consumers. Here’s an example of a press release that the FDIC issues to the public when such a catastrophic loss occurs, this one from October 2020. These releases help remind them that their funds are still safe.
Online and Offline Wallet Risks
The third biggest risk with cryptocurrencies is how they are stored. As cryptocurrencies aren’t physical items, many people choose to keep them online in what’s known as a digital wallet. Although wallets can be stored offline, most choose to keep them online in order to use them.
When a digital wallet is online, it’s open to a number of risks:
An individual or platform hack can allow a malicious hacker to steal digital funds
An error or collapse on a network can cause someone’s data to be lost
Lost or forgotten passwords, which makes it impossible for consumers to access their funds
If that weren’t enough, using a digital wallet actually costs money (yep: that’s a thing).
Some of you will point out that the traditional wallets and purses that we carry on our person can also be stolen. True! But most people don’t keep tens of thousands of dollars in their billfold or purse. But they do in the digital world. That’s because digital wallets are used for both spending money AND for keeping investments.
Other, offline storage options exist such as small USB drives. Accessing the funds on those drives requires - essentially - a username and password. These are known as “public and private keys”. This means consumers need to keep a QR code or a piece of paper with those keys.
As most of you know, it’s very possible to lose drives or pieces of paper.
The Financial Industry Regulatory Authority or FINRA is “authorized by Congress to protect America’s investors by making sure the broker-dealer industry operates fairly and honestly.” So what does that organization have to say about cryptocurrency…?
By comparison, stocks, bonds, and other traditional investments are maintained on registered securities platforms that must abide by regulatory oversight. Oh, and speaking of oversight…
Lack of SEC Oversight
The final issue with any crypto investment is that they have no real oversight.
The United States Securities and Exchange Commission or SEC does not offer oversight on cryptocurrencies. Rather, crypto-investments are still being traded anonymously, a measure that’s beloved by privacy advocates around the globe. It turns out that this feature has a strong downside: transactions that cannot be tracked between individuals or organizations makes any kind of strong oversight difficult or impossible.
While the SEC chair made clear that cryptocurrencies and digital investments “may need to one day register with both the SEC and the Commodity Futures Trading Commission”, there is, currently, no such oversight or registration in place.
Consumers are, therefore, on their own.
One, Last Word
Some of us have the stomachs for incredible risk. Some of us also have money that we consider to be expendable. I get it: if I go gambling at a casino, I walk in knowing full well that - in all likelihood - I’ll walk away with less money than I had when I came in.
But that’s only a few bucks; it’s not losing my entire retirement.
It is essential that - for now - consumers understand that cryptocurrencies are not only risky investments, but they’re also reckless. With no government or central bank backing, with no regulatory oversight, and with no insured funds in the event of a collapse, consumers must understand that they can lose all of their crypto investments - ALL OF THEM - overnight.
The consumers on FTX learned this the hard way. Let their tragic loss be a powerful lesson.
There’s no telling where the cryptocurrency market will head. In the future, the industry might become safer. Regulations and safety standards may be forced upon the largest crypto brokers and platforms. For now, however, it’s impossible to predict what will happen next. And, until real reforms are put in place, investors should either stay away or…
…expect to lose their money.
And that’s a wrap for today’s episode, everyone. Happy New Year and thank you for being a part of our community.
As always… surf (and invest) safe! 👍🏼 👌🏾
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Episode #79: The Fall of Cryptocurrency