A bit more fear, uncertainty and doubt about crypto is welcome

The silver lining to the spectacular collapse of FTX is hard to see if you are one of the 1mn or so creditors in the crypto exchange’s bankruptcy proceedings. That mix of professional groups and individuals will struggle to get any of their money back. Even the new chief executive, a man who once oversaw the liquidation of Enron, no less, said that it was the most shambolic corporate failure he had ever seen.

The whole episode “undermines trust in financial markets”, Citadel’s chief Ken Griffin said in an interview with Bloomberg this week. “The confidence of a generation in financial markets has also been shaken. That’s really awful because the 20-something-year-olds to 40-year-olds who have are so engaged with crypto, they have got to save for their retirement, and if they don’t believe or trust in financial markets, this is a huge problem.”

I wonder whether the opposite might be true. Properly regulated markets may not be perfect, but they suddenly look much more attractive.

Beyond those directly affected, this explosion in crypto hubris certainly appears to have done no harm. The generally upbeat tone in stock markets suggests that fund managers in other asset classes are distinctly unruffled.

Stocks in the crypto sphere have suffered, for sure. Shares in Coinbase, the crypto exchange, have dropped 16 per cent or so since FTX hit the skids, but after a decline of more than 80 per cent since they listed last year, who’s counting? Galaxy Digital — the self-styled “Goldman Sachs of crypto” — has suffered a 19 per cent share price decline. MicroStrategy, the software group moonlighting as a crypto fund, has shed about a third of its value. Between them, and retail broker Robinhood, which dabbles in crypto and counts FTX’s former chief executive as a shareholder, the market capitalisation has dropped more than $6bn to $23bn, according to calculations by UBS.

But some perspective helps here. At $23bn, these companies are together worth just 8 per cent of Meta, UBS notes. The stress is real, but the impact on the wider world is minimal.

In addition, some of the worst fears among regulators around contagion have not materialised. Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management, says he has fielded numerous questions from clients on whether the FTX failure could infect core financial markets. “We think probably not,” he says. “Where it becomes systemic is when it gets into the mainstream finance system through banks. If banks take large losses on crypto, that leads to liquidations elsewhere.” So far, though, that does not seem to be the case.

Perhaps more importantly, the demise of FTX has delivered a tough lesson in two of the guiding principles of money management: do your homework, and keep it simple.

If you ask enough questions about crypto, or express enough scepticism about its grander claims, the true believers will accuse you of spreading fear, uncertainty and doubt, or “FUD”. This is one of the greatest insults they can level at those who have declined to jump on board with the speculative fervour. The problem is not the tokens, or the peculiar new exchanges, they say. It is your ignorance.

It turns out that the world needs more FUD. The dirty little secret here is that too many otherwise rational financiers are routinely failing to ask basic questions about the companies they do business with. Top-flight venture capital firms, each of which threw in hundreds of millions of dollars, have written off investments in FTX altogether. One of them, Sequoia, went to the trouble of writing a near-14,000-word article about the genius of the now disgraced former FTX chief executive Sam Bankman-Fried. Singaporean investment house Temasek has said its $275mn backing of the exchange was “misplaced”. But it defended its “extensive” eight-month due diligence process.

It is hard to imagine what it spent eight months doing, exactly. The bankruptcy filings paint a picture of a cartoonishly amateur collection of FTX executives hopelessly out of their depth and playing fast and loose with the rules.

If venture capital firms lose money on that, so be it. The problem is that their backing really does lend credibility. Some crypto hedge fund managers have said they parked money with FTX because they assumed venture capital firms had done the due diligence. This is nuts. “In VC, the longer you do due diligence, the higher the risk that you will lose the deal,” says one former executive in this space. “There’s a race to the bottom.”

FTX is not the first example of this, of course. But the profile of this case might just help to encourage investors to think for themselves.

Former Bank of England governor Mark Carney made this point in a lecture in 2020. “If someone explains something to you in finance . . . and it doesn’t make sense, ask the person to repeat the rationale, and if that response still doesn’t make sense, you should run.”

Griffin is right to worry about the fate of those stung by the FTX disaster. But if this gives them a nudge towards exercising more FUD, that may be a good thing.


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