Investing Lessons From The Crypto Meltdown

Contributed by Doug Walters , Max Berkovich , David Lemire , Eh Ka Paw

Is it fair to say that FOMO is finally dead in the crypto space… at least for now? The collapse of FTX and its embattled former CEO along with a 75%+ decline in the value of Bitcoin over the past year have taken some of the luster off the space. The lessons for investors from this spectacle are priceless.

If you’ve managed to avoid the FTX saga of the past few weeks, here is the abridged version. FTX, the third largest crypto exchange, run by Sam Bankman-Fried (the crypto posterchild), collapsed and declared bankruptcy. One day it was worth $32 billion dollars, and now it is worthless. From the bankruptcy filing, it appears, at best, there was gross negligence and, at worst, criminal fraud. In a largely unregulated business, no one should be too surprised.

So what are some of the lessons?

• Know the difference between investing and speculating. Cryptocurrencies have only two principal utilities: trading speculation and criminal enterprise. This may change someday, but for now, they have no quantifiable fundamental value, and prices are primarily driven by speculation.
• Beware of celebrities bearing gifts. Real investments do not need help from actors and sports icons to produce attractive returns for investors. With no real value, cryptocurrencies rely on a steadily increasing base of buyers to prop up prices. Celebrities were willing pawns in this speculation machine. We are now seeing what happens when demand wanes.
• Liquidity is important, and many liquidity premiums are a mirage. If you can’t sell your investment or access it when you need it, you better be getting properly rewarded for that risk. With cryptocurrencies, you get illiquidity and high (often uncertain) transaction fees for an asset that has questionable value. Not a good tradeoff.
• Regulation is there for a reason. Purchasing cryptocurrency is the equivalent of stashing money under the mattress. If your house burns down, you have no recourse to recoup those losses. If you forget your crypto key, someone steals your coins, or you accidentally throw your crypto wallet in the trash, you are out of luck.

Investing does not have to be complicated.

• Keep it simple. You should always understand what you own, why you own it, and what it is worth. If you don’t, move on.
• Keep it smart. The wisest thing you can do is not try to outsmart the market. Believing you have found a path to quick riches that the collective knowledge of the entire market has somehow missed is foolish. Investing fortunes are built with patience.
• Keep it selective. You can do better than passively owning the whole market. A Focus on evidence-based factors like Quality, Value, Momentum, and Size has proven over time to produce higher returns. Find proven factors and put them at the core of your portfolios.

It is so easy to get caught in the exuberance of speculation. History is riddled with these examples… tulips, dot-com stocks, US housing… and now crypto and NFTs. They never end well. Investing should not be exciting. If it is, you are probably not investing at all. More likely, you are speculating.