FTX Collapse: Another sign for you to stay away from crypto. Here’s where you can invest instead.

• The collapse of FTX will cast a long and dark winter for the crypto market. Confidence is unlikely to be restored.

• Contagion will likely continue to spread as the space is deeply intertwined with excessive leverage.

• Allegations of fraud will escalate the need for a proper regulatory framework.

• We would like to emphasise that investors should stay clear from speculating in cryptocurrencies. Instead, they should invest in assets with proper fundamentals and real earnings.

What happened to the crypto market

2022 has been a terrible year for the crypto market, filled with leverage, greed, fraud and lack of transparency, and it is unlikely to get better anytime soon. From the implosion of the largest algorithmic stablecoin Terra Luna in May, to the collapse of the multi-billion-dollar hedge fund Three Arrows Capital (3AC) in June, there seems to be no end to the list of bad news even as more than USD 2 trillion has been wiped off the crypto market since peaking in November 2021.

Related Article: Back to Terra Firma – Lessons to be learnt from the Luna/Terra debacle

Cryptocurrencies have always been seen as a form of higher risk, higher beta investment by the wider markets and thus it does not come as a surprise that crypto has not performed well this year in the current risk-off environment, as financial conditions across the world start to tighten. 

Bitcoin, being the bellwether, has fallen 65.4% year-to-date while Ethereum has cratered close to 70%, despite the recent hyped-up merge, while the majority of the alternative coins are down more than 90% from their peak back in November 2021. Meanwhile, traditional asset classes such as bonds and equities have far outperformed cryptocurrencies, despite also falling across the broader markets (Figure 1). 

Figure 1: Cryptocurrencies have severely underperformed traditional assets this year

With the blowup of the world’s second-largest crypto exchange, this crypto winter is likely to be a long and dark one. The unravelling of billionaire Sam Bankman-Fried’s USD 32 billion crypto empire was swift. In less than 72 hours, FTT, the native cryptocurrency token of the platform, FTX, fell by more than 80%, from $22 to a mere $4, wiping out over USD 2 billion in value in FTT token and about USD 200 billion from the entire cryptocurrency market (Figure 2). 

Figure 2: Cryptocurrency market lost around USD 200 billion in market value

Date	Event
2 November	CoinDesk publishes revealing balance sheet details of Sam Bankman-Fried’s (SBF) Alameda Research trading firm, showing it is heavily invested in the FTX exchange’s FTT token
6 November	Binance CEO Changpeng Zhao says he is liquidating his remaining FTT tokens
7 November	Sam Bankman-Fried tweets that “Assets are fine”
8 November	Price of FTT token collapses by more than 80% as clients rushed for the exits and bombarded the exchange with withdrawal requests as FTX halts customer withdrawals Hours later, Binance offered to sign a nonbinding letter of intent to buy FTX as Sam Bankman-Fried reached out to Binance for help as it faced a “significant liquidity crunch”
9 November	However, after due diligence, Binance backs out of the deal, citing issues in FTX’s financial situation that was “beyond its control or ability to help” US regulators reported that they will investigate FTX and its sister entities Alameda Research and FTX US Fear spreads throughout the crypto industry as some exchanges were reported to halt withdrawals
10 November	Alameda Research, FTX’s sister trading firm collapses as FTX desperately tries to raise cash to cover its shortfall
11 November	FTX files for bankruptcy, Founder Sam Bankman-Fried steps down as CEO and flees to Bahamas
12 November	At least USD 1 billion of customer funds go missing from FTX customer accounts

Following the bankruptcy filing, it was revealed that right before the collapse, FTX only had roughly USD 900 million in liquid assets, a far cry from the USD 9 billion in liabilities (Figure 3). As regulators and investigators dug deeper, it was reported that there were at least USD 1 billion of customer funds missing from the exchange, which raised the alarm of a case of potential misuse of customer funds. 

To make matters worse, hackers managed to steal approximately USD 477 million worth of tokens from FTX in the weekend following the bankruptcy announcement, which further deepens concerns about the lack of safeguards within the company. As it stands, investors and customers of FTX are unlikely to ever recover their money.

Figure 3: Gapping shortfall in assets vs liabilities on FTX’s balance sheet

Key takeaways for investors

Whatever the case is, there is no doubt that there are a lot of unknowns and with such serious allegations of potential fraud being mentioned, the downward spiral of crypto assets may perpetuate as confidence among crypto investors continues to wane. 

Not to sound like a broken record, but we have warned investors time and time again to avoid speculating in cryptocurrencies. Since 2021, we have continuously cautioned that cryptocurrency is a zero-sum game more akin to gambling than investing and despite all the promises this profound technology can bring to society, none of it has been delivered but instead, filled with numerous scandals and cases of scams.

As we have mentioned in previous articles, a major shortcoming of crypto is the absence of fundamentals and intrinsic value, which continues to hold true today. The inability to generate any form of cash flow simply makes it impossible to derive an intrinsic value, which gives rise to negative implications such as asset bubbles. While the crypto asset bubble has already ‘popped’ since its peak in November 2021, no one can gauge how low crypto prices can fall since there is no reliable way to gauge its intrinsic value, which makes it not suitable for a long-term investment portfolio, and absolutely not advisable to catch the falling knife.

Related Article: Crypto: Avoid this ‘Greater Fool Investment Strategy’ Asset Class

As it stands, there is still no real world use case for cryptocurrencies, other than the transactions of NFTs (non-fungible tokens) which fluctuate in value based on hype and attention rather than their intrinsic value, and the gimmicky applications in the decentralised finance (DeFi) market. The lack of a stabilising force, coupled with volatility, also makes cryptocurrency a poor form of currency, especially when its existence is in direct competition with central banks, which are rolling out their own version of ‘Central Bank Digital Currency’ (CBDCs).

Related Article: Don’t be tempted by the recent rally – Reiterating why crypto has no place in your portfolio

Lastly, true decentralisation is simply an idealistic utopia as the very reason regulations are set in place is so that the interests of investors and clients are safeguarded. It is also hypocritical to float the word “decentralisation” as a bulwark against controlling central entities since the majority of the cryptocurrencies are held by a few whales, much like how the institutions control most of the assets in the real world. However, the key difference is that there are proper frameworks and regulations set in place to protect the interests of clients in the real world, which are largely not present in the crypto space.

With the collapse of FTX and revelations of shady deals behind the scenes, trust in the crypto space has never been more difficult to regain than before. Furthermore, since FTX is reported to have 134 affiliated companies and more than 1 million creditors involved, we believe that the contagion in the crypto markets will continue to spread and the worst is yet to come, given the intertwined and leverage nature of the crypto industry. 

Looking ahead, regulators will have to step up their game and clamp down more ferociously on the crypto space, in an effort to prevent continued widespread fraud and unregulated casino-like behaviours. Needless to say, confidence in the crypto market has been shaken substantially following these events and it may never recover. 

This is going to be a long and dark winter for crypto, and no one truly knows what the future holds for crypto. However, until there is a better use case, greater transparency and a proper regulatory framework, we would like to emphasise once again that investors should stay clear of this ‘greater fool’ investment asset class.

Where investors can invest instead

Despite the catastrophic failure and collapse of FTX, not all hope is lost.

In fact, if you have lost money in the recent crypto fiasco, you are not alone. Even institutional investors have lost a significant sum of money, with Sequoia and Temasek each writing down their investments worth over USD 200 million in FTX to zero, including dozens of other professional investors.

While it is totally understandable to feel upset over losing your hard-earned money, we should always be optimistic and look at the bright side of things. As humans, all of us make mistakes from time to time. The important thing is that we learn from our blunders to prevent similar occurrences in the future as it will truly be a shame if we walk away without learning anything.

Moving on from here, we urge investors to stay away from cryptocurrencies and instead opt for investments with proper fundamentals, as the price of an asset is ultimately determined by its earnings.

As we head into an increasingly likely recession, we recommend investors to take a more defensive approach, focusing on fixed income and value-oriented equities.

Related Article:  A global recession is likely unavoidable in 2023. Here’s how you can prepare for it.

For investors with a lower risk profile, they can consider allocating a greater proportion of their portfolio to fixed income, namely investment grade bonds, bonds with shorter duration and Singapore-centric bonds, which will likely be more resilient in a rising rate/recessionary environment. 

Related Article – 3 recommended funds that can give you higher rates than fixed deposits

As for investors who would like to adopt a wait-and-see approach and prefer to hold more cash on hand, they can craft a cash management portfolio to better utilise their idle cash. Investors may customise these portfolios to suit their individual risk profile. 

Related Article – DIY Cash Management: More opportunities to earn higher yields

For investors with a higher risk profile, we recommend allocations to US value equities, which are likely to outperform their growth counterparts in the current macro environment. Alternatively, investors who prefer Asian equities can consider the Japanese market, which has more attractive valuations compared to the US market. As for investors who would like more exposure in the emerging market, they can consider an allocation to the ASEAN region which we believe will be more resilient in an economic downturn.

Related Article: ASEAN: Resilience in a sea of uncertainty

Overall, it will be prudent to have a good balance of both bonds and equities according to your risk profile, investment objectives and time horizon.

Related Article: Construct a globally diversified portfolio with SRS-approved funds

Finally, to wrap things up, do look out for our upcoming articles where we will share in greater detail our 2023 outlook and recommended investment themes!

Table 2: Recommended products

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.