The current bankruptcy of bitcoin exchange FTX is sending shockwaves throughout the bitcoin industry. Billions of dollars of bitcoin investments cannot be accounted for. Celebrities like Tom Brady and Matt Damon have been exposed as paid hacks who sold their popularity for compensated endorsements.
Most of the transactions occurred outside the US, making SEC oversight impossible. How much and how little were told to the investors in bitcoins is a matter of speculation. Their losses unfortunately are real.
Earlier this month the FTX exchange, run by a thirty-year-old named Sam Bankman-Fried, sought bankruptcy protection. About $8 billion in prior stated assets have disappeared. It seemed Mr. Bankman-Fried used the clients funds deposited in his exchange to buy bitcoins to instead fund his personal hedge fund, Alameda Research, as well as his lifestyle in the Bahamas.
Those of us who lived through the Dot Com era will recognize Mr. Bankman-Fried’s modus operandi. He would feign indifference as to the intent of the large venture capital firm to commit funds. He would impose a deadline for investing. He prepared incomplete or bogus financial statements. Investors into his firm could either meet the deadline or move on. Very large firms like Sequoia Investments and the Ontario Teachers Union signed on. While their investments are likely worthless, they are large enough that an investment in FTX is more an embarrassment than a crisis.
Investors in the bitcoins that FTX offered to sell tell a different story. These were people who did not understand the nature of their investment, nor the conflict of interest in having an investment held by the same firm that sold it. Their investments individually were in the range of $500 to $100,000. Collectively their sums totaled in the billions. They are for the most part wiped out as well.
To get the small bitcoin investors into the tent, industry advocates recruited stars and sports figures to push the investments onto to the public. Never mind the paid endorsers knew little more than the public in terms of bitcoin’s investment appeal. Some endorsers had invested early on and assumed the party would go on forever. Matt Damon released a commercial for bitcoin investing (“Fortune Favors the Bold”) at the high-water mark for bitcoin valuations. Their value has declined about 75% from its peak.
On their merits, bitcoins are a nebulous investment. The United States dollar is backed by the US Treasury. The British Pound is backed by the Bank of England. Who backs bitcoin, the Wizard of Oz? Still, millions invested in bitcoins due to their hype of promised returns, fear of missing out, peer pressure (especially on the internet and social media), an ignorance of history and a lack of critical thinking.
Bitcoins and their technology that made them possible, blockchain, first appeared fourteen years ago. The appeal of bitcoins first was apprised by those of libertarian disposition, who saw bitcoins as a way of circumventing the government’s ability to track transactions using that government’s currency. The idea was to permit income and assets to be transferred without government oversight. In time a criminal element was attracted, first for the ability to transfer assts, then for the ability scam investors with a vehicle that could be promoted online while operated outside the US. This last point is especially important. If bitcoins had been promoted by a domestic organization, disclaimers such as “Not insured/ May lose value” would have been required. Since the bitcoin custodians and transactions were outside the US, no warning was necessary.
As usual for such a situation, politicians are calling for industry regulation and classifying bitcoins as investments. Such a designation would put bitcoin purchases and sales under the auspices of the SEC and by extension the IRS. From there, regulation as to their promotion and transparency would follow. It is an open question whether bitcoins could survive as an investment in such an environment. All current investors in bitcoins want is for them to go up. The reason why is not important. When they stop going up, those looking for a fast return will go elsewhere.
It is also a given that movie stars and sports celebrities will think again before lending their name and reputation to something they know not of. The public will soon forget the endorsements. Those who lost money perhaps because of them will take longer. No doubt there will be more blow ups and bankruptcies of bitcoin firms. So far, the effect on more established markets is minimal. That may change if losses among investors mount and stocks and bonds must be liquidated to make margin calls.
The Economy
With ocean shipping now normalized, it appears that the economy is slowing at an accelerating rate. Some of this is inventory digestion, as items ordered earlier or perhaps double-ordered arrive. Current orders are deferred until inventory normalizes. Fed Ex Ground announced that they have started furloughs of trucks and employees. Coming a month before Christmas, the cutbacks are unheard of for this time of year. Some believe this reflects less an overall slowdown and more of a contraction of e-commerce after years of explosive growth.
Interest Rates
After the last rate hike, the consensus seems to be for smaller hikes going forward. There is no talk yet for interest rate decreases. Mortgage rates seem to have fallen below six percent this past week, as demand for mortgage applications contracts. The housing market is seeking to normalize at a lower price level to accommodate higher interest expenses. Tightening of funds can be seen in the higher interest rates offered on Certificates of Deposit. It is assumed that the government bond portfolio runoff is proceeding apace.
Inflation
News about inflation should be improving as we lap the increases of a year ago. Even if inflation continues, the rate of gain should subside. Food bills remain elevated as a drought on the Mississippi restricts barge traffic. Housing costs are still high but not increasing as housing prices moderate and rents increases are curtailed.
The Stock Market
The November-January time of year tends to be good for stocks overall, as most companies
are on calendar years. The new year means a new set of earnings forecasts that tend to move stocks higher. Possible disruptions to this outlook will be the threat by the new House leadership to prevent raising the National Debt ceiling, jeopardizing Medicare, Social Security, and the country’s bond rating in the process. For this reason, it is expected that the debt increase issue will be taken up by the lame duck session of Congress prior to the next session being installed in January. Other political disruptions could come from funding for Ukraine. The Republican House leadership seems to be critical of the amounts spent, while advocates of funding Ukraine speak of the parallels between the situation there and Czechoslovakia in 1938. To the extent the parallel holds, it is better and cheaper for the US to engage in a proxy war there rather than one in Europe or the Eastern US.
Warren M. Barnett, CFA
November 22, 2022
Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or [email protected] to set up a meeting with one of our investment advisors.
Thank you!