Bahamas-based crypto exchange FTX filed for bankruptcy in the US on November 11, 2022, seeking legal protection as it seeks a way to return funds to users.
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After a difficult year for digital assets, the recent collapse of cryptocurrency exchange FTX caught many investors unaware as clients awaited answers of an estimated $1 billion to $2 billion in missing funds.
While the company’s future — and investigations into its dwindling assets — hang in the balance as FTX enters bankruptcy protection, experts say there are important lessons for crypto investors.
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“The FTX collapse is a stark reminder that there is no such thing as a free lunch when trying to make a quick buck in what is still a fairly new, unregulated financial industry,” said Certified Financial Planner Jon Ulin, CEO of Ulin & Co. Wealth Management in Boca Raton, Florida.
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You should invest “what you are 100% willing to lose, like in Vegas” and “discretion and skepticism” should be exercised when evaluating assets and related products offered by “professional athletes, celebrities and media personalities” said Ulin.
Here are four more investor lessons from FTX’s demise.
1. Know the risks of where you hold cryptocurrency
Kevin Lum, a CFP and founder of Foundry Financial in Los Angeles, works with younger investors and said about 50% of his clients hold crypto in some form.
While he doesn’t necessarily think clients need to reduce their risk, he said they need to understand where digital currencies are held and the potential risks of holding assets there.
“I think the collapse of FTX will end up being good for traditional financial firms like Fidelity entering the crypto space because they come with a level of confidence,” Lum said.
Earlier this month, Fidelity Investments announced plans to launch a commission-free crypto product that would allow investors to buy and sell bitcoin and ether.
The FTX collapse has also reignited interest in cold storage, or using digital currencies offline, making them less vulnerable to hacks. However, the move makes assets less liquid and more difficult to trade quickly.
2. Diversification is “always important”
Whether you invest in stocks, cryptocurrency, or other assets, experts say a large percentage of a single holding can be risky.
“Diversification is always important,” said George Gagliardi, a CFP and founder of Coromandel Wealth Management in Lexington, Massachusetts.
“For individuals who had a very high allocation to cryptocurrencies, whether in FTX or not, this year’s crypto price crashes have been a painful lesson in the importance of diversifying one’s asset classes,” he said.
Since surpassing an all-time high of $68,000 in November 2021, Bitcoin’s price has fallen by more than three-quarters, falling below $17,000 on November 17.
“That [FTX] The collapse should be a lesson that any single company – be it a crypto exchange or a more traditional company – can go bankrupt in times of need,” said Kevin Brady, a CFP and vice president of Wealthspire Advisors in New York.
When weighing portfolio allocations, 5% of a single asset is “beginning material” and 10% is “very concentrated”. Of course, extenuating circumstances may exist for some investors.
“Even if a financial asset is speculative in nature, it can still play a role in a well-diversified portfolio, albeit in small amounts,” said Ulin of Ulin & Co.
3. Expect more crypto regulation
There has been an ongoing debate on how cryptocurrency should be classified and regulated, and it has intensified amid the FTX fallout.
Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, DN.Y., introduced legislation in June to create a digital currency regulatory structure that would define the majority of assets as commodities, such as gold or oil, to be regulated by the Commodity Futures Trading Commission.
Experts say the FTX meltdown could accelerate those discussions — and speed up the timeline for future policy. “I think we’re going to see regulation,” said Ivory Johnson, a CFP and founder of Delancey Wealth Management in Washington. “And I think these bad business models will go away.”
House Financial Services Committee Chairwoman Maxine Waters, D-Calif., and senior Republican Rep. Patrick McHenry, of North Carolina, on Wednesday announced plans for a December bipartisan hearing to probe FTX’s collapse .
While Congress will ultimately decide how government agencies can regulate cryptocurrency, Securities and Exchange Commission Chairman Gary Gensler is pushing for stricter rules. “Investors need better protection in this space,” he told CNBC’s Squawk Box on Nov. 10.
4. Back up your crypto transaction records
Regardless of where you store digital currencies, experts recommend regularly downloading your transaction history.
Gathering reporting documents is one of the most difficult parts of crypto taxes, said Andrew Gordon, tax attorney, CPA and president of the Gordon Law Group. And when an exchange closes, you still need paperwork to file your return, he said.
“Two weeks ago, very few people suspected that FTX would face this,” Gordon said.
Plus, you’ll have a better sense of your gains and losses by tracking year-round, he said, making it easier to trim your bill with strategies like tax-loss harvesting. “It will put you in a much better position when tax time comes,” he said.