In 2008, the subprime mortgage crisis resulted in the fall of Lehman Brothers, where I worked as a global investment banker in the 1990s.
It took other “too big to fail” banks to the brink of collapse.
My former employers, JPMorgan Chase and Goldman Sachs, made that list. So did other major banks, like Bank of America and Morgan Stanley.
The fallout caused a global recession. And it led to a significant drop in the growth rate of the world economies.
15 years later, the mainstream media is saying a similar Lehman moment may be upon us. This time in the crypto markets.
I’m talking about this week’s collapse of the popular crypto exchange, FTX. The same one Tom Brady and Larry David promoted at Super Bowl halftime earlier this year.
So today, I want to pull back the curtain on this story and show you what it means for you.
The Fall of An Empire
FTX was the brainchild of billionaire Sam Bankman-Fried (aka SBF). And until recently, it was the fastest growing crypto exchange.
In 2021, FTX and its biggest rival, Binance, traded over $7 trillion worth of volume on their platforms.
Binance held $500 million worth of FTX’s tokens. That is, until it decided to sell them a few days ago.
Binance’s CEO, Changpeng Zhao (aka CZ), said in a tweet:
Due to recent revelations that have come to light, we have decided to liquidate any remaining FTT [FTX’s token] on our books.
CZ didn’t say what revelations he was referring to.
But many speculated it was a leaked balance sheet of Alameda Research. That’s a crypto trading firm owned by FTX’s Sam Bankman-Fried.
That balance sheet revealed the firm was seemingly propped up by FTX’s own token, FTT, to the tune of nearly $6 billion.
As a result of these revelations, the price of FTT dropped more than 85% as fears over the financial position of FTX escalated. This spelled disaster for FTX.
In the 72 hours leading up to Tuesday morning, there had been roughly $6 billion of net withdrawals from FTX.
On an average day, net inflows are in the tens of millions of dollars. In other words, it was facing a bank run.
Then, in a stunning turn of events, earlier this week Binance said it would acquire FTX… only to back out of the deal yesterday.
This effectively leaves the crypto exchange on the brink of collapse or bankruptcy, adding fuel to the fire.
You see, FTX is not just a small, no-name crypto company. The exchange hit a valuation of $32 billion at the start of this year.
Blue-chip investors backed it – including BlackRock, Canada’s Ontario Teachers’ Pension Plan, and SoftBank.
Celebrities also showered FTX with support. On that list were supermodel Gisele Bundchen and her husband, famous NFL quarterback Tom Brady.
In an industry that has been called the “Wild West” by Wall Street’s top regulator, a lot of people thought of FTX as one of the better-managed players.
Bankman-Fried, its founder, even lobbied lawmakers in Washington regularly.
From $32 Billion to Potentially Nothing
So how does a $32 billion company collapse almost overnight – just because a rival threatens to sell $500 million worth of its tokens?
It all comes down to confidence, as the infamous Charles Ponzi would say.
Imagine that I print up 32 sports trading cards. (In some ways, that’s what FTX did when it created its own FTT token.)
I then somehow manage to sell one of them for $1 billion. Now, my market valuation shows I’m worth $32 billion (32 cards multiplied by $1 billion).
But that’s just the market assuming (or being confident) that I could sell another card for another billion dollars… and then another one… and another.
So, most of my net worth – on paper – is tied to these cards. But what if the market finds out I’ve literally been printing these cards out of thin air?
Well, then – unless I’m the Federal Reserve – I‘m probably going to see some sort of crisis of confidence.
As this realization reverberates through the market and my pool of buyers dries up, demand for my cards craters.
And with no one out there to buy them from me, I’m not worth $32 billion anymore. In fact, I’m probably worth nothing. Zero. Zilch.
Now I’m not saying that this is exactly what happened at FTX. But it does help explain how the exchange could have gotten itself into a liquidity crunch.
Bringing It All Together
So, here’s my take on the whole FTX drama.
This is a company that was highly leveraged, and potentially dishonest with its reporting.
In any sector, including traditional banking and finance, that can spell disaster. I know because I spent 15 years on Wall Street.
I was there in the lead-up to the ’08 crisis. And Wall Street’s penchant for making risky bets with other people’s money is a big part of why I walked away.
Today, this disaster has happened in the crypto world. The industry was already reeling from a 60% drop in the total crypto market cap. That was before the FTX story broke.
The Fed’s aggressive rate hikes haven’t helped crypto this year, either…
And the crypto markets are also coming off a streak of bad events, which I wrote to you about in these pages previously.
Bottom line…
I’m not surprised that the level of fear in this market is reminiscent of the uncertainty brought about by the Lehman Brothers collapse back in 2008.
Unfortunately, that means things could get worse before they get better.
Especially if no one else comes to FTX’s rescue following the Binance withdrawal.
This wouldn’t be too surprising given that there’s reportedly an $8 billion gap in FTX’s financials.
It would add even more uncertainty to already troubled markets.
What This Means for Your Money
If you own Bitcoin, which I’ve written about in these pages, you might be wondering what this means for you.
On the one hand, it’s not Bitcoin’s fault that FTX was a poorly managed company.
Unfortunately, even though it wasn’t directly connected to these stories, Bitcoin has suffered even more in the aftermath. It’s down over 20% since the story broke.
You may be tempted to sell.
But anyone who’s tried their hand at investing will tell you that it’s never a good idea to sell into panic. Even – or especially – if it seems like everyone else is doing it.
Yes, the crypto market is wrapped in uncertainty right now. But I believe we will see Bitcoin rebound from these fear levels eventually.
I’m not losing confidence in Bitcoin just because someone gambled with other people’s money.
As I saw during my years on Wall Street, many companies came back even stronger after the initial fallout from some of the mistakes that were made.
And as I told you recently, history is on Bitcoin’s side. It’s a good inflation hedge.
Earlier this year, the White House acknowledged cryptocurrencies as a legitimate and important part of American society and the U.S. economy.
And as I showed in previous essays, the 21 million cap on the number of Bitcoins, plus the ever-decreasing pace these are issued, means each Bitcoin will become more and more valuable in time.
So if you currently hold Bitcoin, my advice to you right now would be to stay patient and ride out this current volatility.
And if you’re considering tiptoeing into Bitcoin, I’d wait out this turmoil and see if there are any other FTXs out there, first.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins