December 2, 2022

Exactly how Easy Money Fueled the FTX Crypto Collapse

A lot of investors forget that when the simple money is flowing, financial mediocrities and even outright scams can be made to look like legitimate geniuses

The collapse of the crypto exchange FTX may end up being a canary in the fossil fuel mine of the easy-money-fueled crypto bubbles.

FTX’s collapse provides exposed just how little due diligence is actually taking place among investors, who are apparently willing to place large amounts of cash in no matter what looks like the hottest new matter and promises— without convincing evidence— big-time returns.

Indeed, FTX appears to be a textbook example of the number of investors are easily hoodwinked simply by media narratives about the newest investment genius who has magically discovered some new way of delivering unprecedented returns.

The “ genius” in this case is Sam Bankman-Fried (SBF), a thirty-year older MIT grad who happened to run FTX into the ground and had placed control of his clients’ money in the hands of a small number of friends with virtually no real experience, knowledge, or scruples about how to reliably manage funds. Financial record keeping and reporting on the company were haphazard best case scenario.

The calculations will be murky for a while, but it now looks like FTX has “ lost”   at least $1 billion in order to $2 billion   of client funds, let alone billions of dollars in assets in the company that evaporated. Much of it was probably simply stolen. But it’s difficult to guess at this point because FTX  didn’t bother to build an accounting department . FTX’s new CEO reports that the state of the carrier’s financial management  is worse than Enron’s.

Yet numerous thousands— possibly more than a million— clients were willing to pour money into the exchange.   Some put in almost their entire net really worth . Institutional investors put in much more. Sequoia Capital, for instance , famously   put $210 million into FTX . “ Due diligence” involved a “ last-minute Zoom call ” with Bankman-Fried during which he played video games. That will money is now all “ missing. ”

Why were so many willing to so carelessly hand over much of their life savings for an operation run by a man-child in short pants who was basically accountable to no one? The solution lies in the fact that when we mix speculative manias with decades of central-bank-fueled easy money, we end up with a world by which FOMO and a desperate look for yield lead to disaster. The FTX implosion is exactly what we should expect to see as our own decade-old bubble economy relates to grips with rising interest rates, a slowdown in simple money, and a looming economic downturn.

Slowing Financial Inflation Creates a Problem meant for Leveraged Crypto

As  I showed earlier this week , the particular tech sector overall is usually facing losses and a requirement for cost cutting as the price of borrowing— i. e., curiosity rates— goes up.

Up until this year, this inevitable economic decline was frequently delayed because many complications and inefficiencies in a business  can be papered over when it’s always possible in order to borrow more and pay off aged debts with new cheaper debt . The gambit works when interest rates are usually continually falling, as has been the case over the past forty yrs. That is, it was easy to perform so  until lately . Now that firms cannot always count on more inexpensive money coming down the road, loss and out-of-control expenses become a problem.

Whenever borrowing costs go up, inefficient and fraudulent companies possess a harder time covering upward losses and a lack of income. This becomes especially difficult for highly leveraged businesses that have enormous debt-service expenses, engage in financial shenanigans, and take on high-risk investments such as derivatives.

Recently, we’ve begun to see crypto exchanges get into trouble intended for similar reasons. FTX is simply the most spectacular recent example, but FTX could have held its problems hidden longer had the easy money kept flowing as usual.

Here’s what happened: As a crypto exchange, FTX functioned relatively like a quasi-bank. Clients place money into the exchange in order to facilitate client investments plus use their crypto to both invest and consume. Much of this also revolved close to FTX’s crypto token referred to as FTT. Clients were “ depositors” of a sort. Just like a bank, however , FTX also tried to make money by making assets of its own through a sister company, a crypto-trading firm called Alameda Research. FTX was effectively acting being a fractional-reserve bank, using client “ deposits” to make speculative investments through Alameda.

But then the easy-money economy tightened up slightly this year as the Federal Arrange raised rates and backed off on quantitative easing (QE). One effect of this was falling prices for a variety of cryptocurrencies, FTT among them. Investors— both small-time crypto customers and large institutional investors— began to sell their crypto or forego new buys in order to get liquidity for use somewhere else. As a result, ordinary clients at FTX began to withdraw their particular holdings. Meanwhile, the large crypto exchange Binance began to market its own considerable holdings associated with FTT. Suddenly, FTX needed to give large numbers of departing customers their money back. But FTX had already committed a lot of its money elsewhere: like many investors, Alameda and FTX were making riskier bets in an effort to stay ahead of inflation in a Fed-created world of ualow yields.

FTX then found that it didn’t have enough liquidity to meet its obligations in order to clients. Moreover, as the Given scaled back on QE and the economy slowed, asset prices began to stagnate. This particular meant FTX’s collateral has been losing value and could not have to get easily sold to cover customer withdrawals. On November eleven, it all collapsed.

This wouldn’t have happened— at least not  at the moment — had the easy money still been flowing. Clients would not have lost desire for FTT tokens to the same extent, and FTX can likely have taken out a few new loans to cover whichever rising costs it was dealing with. The can would have been kicked down the road yet again.

But as it has been, there simply wasn’t sufficient liquidity anymore for the rip-off to continue.

Hence, we find that leveraged crypto faces many of the same issues that other highly leveraged high-risk ventures face. Once the easy money dries up, financial obligations remain, but new financial loans to pave over the troubles are difficult to come by. This issue was  noted several weeks ago by bitcoin consultant Caitlin Long   of Custodia Bank, who seem to opposed leveraged crypto— we. e., unbacked “ savings” — as  a form of circulation credit .

From Yield Starvation to Collapse

SBF was able to keep up the ruse for years in spite of his manifestly dishonest business practices, absurd accounting, and good old-fashioned grifting.

But the fact is that numerous investors are so susceptible to cons like those promoted by SBF because investors  want  to believe them. Thanks to “ yield starvation ” brought on by  years of economic repression , investors are desperate to find a hero who can promise big returns, even if the risks appear to be high. As economist Brendan Brown  has noted , there will always be speculative narratives and manias. But when the search for yield becomes especially acute, things are made far worse.

The financial industry then becomes enamored associated with financial celebrities like SBF.   Fortune   magazine featured SBF on its cover. Numerous news programs featured SBF as a wunderkind expert at the new economy. This was more enhanced by the fact that a lot of the client money SBF mismanaged— i. e., stole— had been used for enormous public relations advertisments designed to burnish his image and clout. He gave immense amounts of money to the Democratic Party and utilized funds to win over countless elites in the media. Even while SBF’s fraud was exposed, the   Nyc Times   and the  Washington Publish   were nevertheless running articles about how SBF and his associates are  merely misunderstood do-gooders . SBF  himself accepted   his image was all part of a con.

The particular PR worked, and speculators hopped up on easy cash continued to put money straight into FTX with little in order to no true due diligence. A lot of investors forget that when the easy money is flowing, financial mediocrities— and even outright frauds— can be made to look like genuine geniuses. Unfortunately, it often demands only the smallest amount of financial tightening to expose the grift, and then the party has ended.

Leave a Reply

Your email address will not be published. Required fields are marked *