FTX COLLAPSE: Risk Management Lessons to Save Your Money

 

FTX Collapse, Lessons In Risk Management

The FTX collapse is a cautionary tale of many things, greed and hubris among them of course, but also a failure to really appreciate the importance of risk management. Many unsophisticated investors wonder why you would need to bother with complex models, when you can simply invest in an index fund or base your strategy on financial press hype. 

Well Sam Bankman-Fried and his cohorts offer a pretty instructive masterclass about why risk management is not only important but vital to investors of all stripes. 

 

Elementary Mistakes

The crypto exchange that Sam Bankman Fried, or SBF, founded was FTX. It received institutional backing and support from popular media figures like Mr Wonderful of Shark Tank fame; even world leaders like Tony Blair and Bill Clinton were on the payroll. They all claimed to have done their due diligence; and yet the signs were all there. The CEO of Alameda Research, basically FTX’s Hedge Fund, admitted on camera that she only used elementary school math for risk and that stop losses are not a good risk management tool, according to her a ‘tolerance for risk’ is all that’s required.

 

Going Beyond Risk Tolerance

This is a wild statement to make for a company whose founder was touted as the next Warren Buffett on the cover of Fortune magazine. 

Math is the underpinning of risk management, even the worst risk model uses math that goes way beyond basic addition and subtraction. There is much more at play. It is perilous and shortsighted to focus exclusively on your tolerance for risk, the purely psychological aspect of investing. For example when the market is up, it’s all about how much volatility you can take, but when it unravels in as little as 48hrs, it’s all gone. At this point you should realize there is much more to this than simple tolerance for risk.

 

Why did FTX Collapse? 

Binance essentially set in motion a bank run after announcing they wanted to sell their FTT tokens issued by FTX. Binance was not only the major rival of FTX but had the largest holding of the tokens. Around this time it came to light that Alameda Research was making risky loans with FTT and after Binance wanted to sell, everyone rushed to withdraw funds. 

The real meat of the story is the $8 billion shortfall, it appears that Alameda was dipping into customer accounts and lost money on bad trades or perhaps something more sinister. At this point it is not clear how much malice or incompetence to assign to their operations. Either way it doesn’t look good for people hoping to get their money back. 

 

Lessons To be Learned

Risk management is about more than how much tolerance you can take. But more importantly if it looks like a ponzi scheme, walks like a ponzi scheme and talks like a ponzi scheme; dear readers do not be fooled, it is a ponzi.

To get more on this story listen to the Investing Counterpoint podcast now. 

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