'There is no such thing as a free lunch.' 4 lessons for crypto investors from the FTX collapse
- There are key lessons for digital currency investors after the downfall of cryptocurrency exchange FTX, financial experts say.
- "The FTX collapse provides harsh reminders that 'there is no such thing as a free lunch' when trying to make a quick buck in a still fairly new, unregulated financial industry," said Jon Ulin, CEO of Ulin & Co. Wealth Management.
After a difficult year for digital assets, many investors were blindsided by the recent collapse of cryptocurrency exchange FTX, as customers wait for answers about an estimated $1 billion to $2 billion of missing funds.
While the future of the company — and investigations into the vanishing assets — are in limbo as FTX enters bankruptcy protection, experts say there are key lessons for crypto investors.
"The FTX collapse provides harsh reminders that 'there is no such thing as a free lunch' when trying to make a quick buck in a still 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 willing to lose 100%, like in Vegas," and "discretion and skepticism" should be exercised when weighing assets and related products pitched by "pro-athletes, celebrities and media personalities," Ulin said.
Here are four other lessons for investors from FTX's downfall.
1. Know the risks of where you're holding 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 exposure, he said they need to understand where digital currency is held and the possible risks of keeping assets there.
"I think the collapse of FTX will end up being good for traditional finance companies like Fidelity who are entering the crypto space, because they come with a certain level of trust," Lum said.
Earlier this month, Fidelity Investments announced plans to launch a commission-free crypto product, allowing investors to buy and sell bitcoin and ether.
The FTX collapse has also renewed interest in cold storage, or taking digital currency offline, making it less susceptible to hacks. However, the move makes assets less liquid and harder to trade quickly.
2. Diversification is 'always important'
Whether you're investing 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, the crypto price crashes this year were a painful lesson in the importance of diversifying one's investment classes," he said.
Since topping an all-time high of $68,000 in November 2021, the price of bitcoin has plummeted by more than three-quarters, dropping below $17,000 as of Nov. 17.
"The [FTX] collapse should be a lesson that any individual company — be it a crypto exchange or more traditional business — can go bankrupt in times of distress," said Kevin Brady, a CFP and vice president of Wealthspire Advisors in New York.
When weighing portfolio allocations, he said, 5% of a single asset "starts to be material" and 10% is "very concentrated." Of course, there may be mitigating circumstances 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's been an ongoing debate about how cryptocurrency should be classified and regulated and it has intensified amid the FTX fallout.
Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., in June introduced a bill to create a regulatory structure for digital currency, defining the majority of assets as commodities, such as gold or oil, which are overseen by the Commodity Futures Trading Commission.
Experts say the FTX meltdown may accelerate these discussions — and speed up the timeline for future guidelines. "I think we're going to see regulations," 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 the ranking Republican, Rep. Patrick McHenry, of North Carolina, on Wednesday announced plans for a bipartisan hearing in December to investigate FTX's collapse.
While Congress will ultimately decide how government agencies may regulate cryptocurrency, Securities and Exchange Commission Chair Gary Gensler has been pushing for tighter 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're holding digital currency, experts suggest downloading your transaction history periodically.
Gathering reporting documents is one of the most difficult parts of crypto taxes, said Andrew Gordon, tax attorney, CPA and president of Gordon Law Group. And if an exchange closes down, you'll still need records to file your return, he said.
"Two weeks ago, very few people suspected FTX would be facing this," Gordon said.
Plus, you'll have a better feel for your profits and losses by tracking throughout the year, he said, making it easier to trim your bill with strategies such as tax-loss harvesting. "It will put you in a much better position when tax time comes," he said.