(15-Nov-22) What the FTX is going on?

Important & Trending

Twitter “Blues”

Elon Musk hasn’t been in charge for long, but he’s already put legitimacy up for sale and made insulin-free, crazy huh? Social media is a powerful, strange, and terrifying thing. A few mishaps and already the water is Musk-y. Under a new subscription service (which has since been revoked) named Twitter Blue, users could verify their accounts with the blue little checkmark as long as they opted in to pay $8/month. This harmless little tweak cost pharmaceutical giant Eli Lilly and Company (LLY) millions over the weekend. Why? Well, fake (but verified) Twitter account @EliLillyandCo tweeted last Friday: “we are excited to announce insulin is free now” which sent the LLY stock plummeting, forcing the actual (and verified?) Eli Lilly to make a tweet basically saying hey that wasn’t us, this here handle is our official page ya-da ya-da. Eli Lilly wasn’t the only victim, aerospace defense company Lockheed Martin also lost billions in share value (shares fell over 5.5%) as another impersonator said it would stop selling weaponry to specific *cough* countries. Other companies like PepsiCo, Musk’s Tesla and SpaceX, as well as Roblox, and Nestle also suffered similar fates when fake accounts made more obviously satirical tweets. Seems Musk didn’t really think this one through, and maybe that’s paying off? Twitter usage is at an all-time-high.

How US elections could affect the markets

The US midterm elections are still not over, but it’s a close one – and hey it’s looking like a split government, which generally investors tend to favour because it means less legislation (because it’s harder to agree on things). Here are the takeaways from this election:

1. Voters were heavily concerned with the Fed. Inflation was most central to voting decisions even more than crime, energy, or other hot topics (it wasn’t even on the radar 2 years ago). Markets rallied last Thursday after news that inflation cooled more than expected last month, which suggests the Fed might slow its rate hikes.
2. No one politician or party has overarching control over the markets. “Keep in mind how little control any given set of politicians has over the stock market or the economy in general,” says Dan Egan, Vice President of Behavioural Finance at Betterment. If you take investment risk off the table in response to these results, you could miss out on the market’s upside.
3. According to a US Bank analysis, the S&P 500 Index tends to beat the overall market in 12 months following a midterm election, with an average return of 16.3%.

So, yeah – keep it cool, keep it chill. 

What the FTX is going on?

Remember last week when we said we were watching that story on whether or not Binance was going to buy out FTX? Maybe you’ve heard, or maybe you haven’t, but here’s the low-down (also keep reading for our opinion piece on this whole debacle below). Crypto boy-wonder Sam Bankman-Fried (known as SBF) founded Alameda Research in 2017 – a hedge fund dealing in crypto. A couple of years later, he founded FTX (Futures Exchange) which later became the second-largest crypto exchange in the world. SBF’s success was so astonishing that he was compared to being the Warren Buffett of the crypto world… all due to his two separate companies. Separate here being the keyword. Turns out it was all a big escándalo! On November 2nd, a story broke that Alameda Research was financially dependent on FTT (the FTX token). So Binance naturally backs out of the deal to buy FTX  amid concerns about the company’s health. Chaos ensues as people try to withdraw money, but FTX has no money to give back. Ouch. FTX’s turmoil has sent crypto prices falling, with Bitcoin and Ethereum dropping more than 20%. Some are calling this the worst crisis to hit the crypto world, well, ever. And regulators are in the spotlight. 

The Big Story: FTX, a success story gone wrong

Enron, Lehman Brothers, and now FTX. Last week was host to a financial scandal of epic proportions: an influential main character, hidden agendas, complex structures, and in the end, a broken facade. 

Earlier in the year, FTX bailed out a couple of crypto platforms, with Sam Bankman-Fried (known as SBF) hailed as a game changer in the space. Fast forward to November, and the tables seem to have turned in quite a drastic fashion. What started as a tweet-off between the CEOs of the two largest crypto exchanges, has unfolded to become the first scandal since the 2008 crisis, resulting in FTX filing for voluntary bankruptcy. While apologies have been communicated by the crypto mogul himself, it’s hard to believe that affected clients will accept them. 

Based on current allegations, one can clearly see how the situation has unravelled: the mishandling of client assets, strong financial links between sister companies, and risky bets. To add to that, FTX’s (the exchange) main competitor’s CEO (CZ) held a sizable portion of FTT (the token), which resulted in the currency’s collapse once CZ communicated he was planning to sell that position. This resulted in a typical bank run situation, but as investors rushed to withdraw funds, little did they know, their funds were already gone. 

We can point fingers at multiple parties here, with SBF being the main target, obviously. As things stand today, he’s been portrayed as the engineer behind the off-the-book transactions, making use of the advanced structures put in place, and avoiding regulatory scrutiny in the process.

This brings us to our second point: regulators. Since day one, crypto has been praised by its proponents as the way to go moving forward, with decentralisation at the heart of their advocacy. While the benefits are understandable, the past few years have shown us the flip side of this emerging market. In 2022 alone, we’ve seen the liquidation of multiple crypto assets, the occurrence of major hacks, and now the collapse of a major exchange. What’s notable here is that this collapse was not due to a fundamentally weak market, but a lack of regulatory oversight and robust guardrails. 

Following the mortgage-backed securities scandal in 2008, regulations were set in place to prohibit banks from investing in risky assets and speculating with funds they hold. This was subsequently known as the Volcker rule. This put strong constraints on institutions to avoid large losses from proprietary trading. Regardless of the efficacy of this regulation, it certainly added layers of protection for depositors. 

Although decentralisation is what makes crypto so alluring, the FTX debacle highlights its many existing flaws. Similar to how the financial landscape has undergone regulatory changes following the 08’ crisis, we should be open to implementing further protection, to some extent. The purpose of that wouldn’t be to centralise, but rather to set an oversight system on parties that execute, hold, and facilitate client funds and transactions.  

While investment vehicles change over time, people in power might not. Historically, when loopholes are found, they’re abused. Think of Bernie Madoff. His whole Ponzi scheme was uncovered once markets went sour. With the ongoing change in regulatory structures after the longest bull market in history, and as interest rates rise further and capital is made more expensive to obtain, flawed business models should come to surface. The fundamentals of investing in traditional financial markets shouldn’t be that different from crypto. While investor due diligence is essential, it would most probably be worthless without proper regulatory infrastructure.