Catastrophic Loss and the FTX Fraud

Author: Patrick Blair

I recently met a sophisticated, 45-year-old* salesman who said he’d just come out of retirement, because he lost 90% of his net worth in the FTX bankruptcy.  As a result, his wife was seriously considering divorcing him and taking their young son with her.  He told me, “What are you gonna do?  Cry about it?” as if to say, ‘life moves on and I’ll keep moving forward.’  While I was impressed with his fortitude, my heart still sank.

The situation reminded me of this passage:

      I have seen a grievous evil under the sun:

wealth hoarded to the harm of its owners,

     or wealth lost through some misfortune,
so that when they have children
     there is nothing left for them to inherit.
   Everyone comes naked from their mother’s womb,
     and as everyone comes, so they depart.
They take nothing from their toil
     that they can carry in their hands.

                                                  –Ecclesiastes 5:13-15 (NIV)

If you haven’t heard: FTX was a major crypto exchange that went bankrupt because its founder and CEO, Sam Bankman-Fried, used customer deposits to cover investing losses.  It is unclear at this point if some of the funds were just outright stolen.  The latest estimate is that FTX lost $8 billion in customer deposits!  The nickname ‘Sam Bankman-Fraud’ is well-deserved.

There’s so much to talk about here, but I want to focus on one thing: the importance of diversification (Ecclesiastes 11:1-4).  The Bible doesn’t give specific investing advice (sorry, no stock picks) but does provide important general concepts that should be followed.  If the salesman had been diversified, he could have stayed retired (not that being retired is the be-all-end-all).

So, how did the salesman retire before he was 45?  He had invested early in Tesla and Bitcoin.  Although both assets have fallen recently, the larger problem here was where he kept wealth.  If it had been kept at another exchange or in a crypto wallet, it would have been intact (for now anyway).  Where you keep your money is part of diversification.

This may seem like an obscure point, but I assure you it is not.  FTX wasn’t FDIC insured and lacked the transparency that other financial institutions have.  Keep in mind, however, that most major financial institutions nearly collapsed in 2008.  So, no bank, exchange, brokerage, insurance company, or financial institution is completely safe.  To be sure, some are safer than others, but there are always risks.

Celebrities such as Tom Brady, Gisele Bundchen, Kevin O’Leary (a.k.a. Mr. Wonderful), Steph Curry, Shaq, and Larry David (ironically) endorsed FTX.  The FTX logo was on a sports arena, sports jerseys, and Formula 1 racecars.  With such widespread exposure, how could FTX have been a fraud?  It’s hard to blame the salesman for believing that FTX was a safe place to park his funds.  The lesson I take from this is that no one is immune to loss (not even the wisest of us).

There are many investments that are perceived to be very safe, where you might experience loss in the future.  It could be a pension or a brokerage.  It could be real estate investments.  It could be the stock market.  It could even be an entire currency.  It could be anything!  That’s why it’s so important to understand wide-level diversification and to not have all your eggs in one basket.  Diversifying doesn’t make you rich, but it keeps you from being poor.

*I don’t know exactly how old the salesman is, but 45 is an educated guess based on his appearance and other things he said.