FTX and the Fallout: how crypto investors can pivot and still find crypto-like gains
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
The collapse of the FTX crypto exchange, Alameda Research (a sister company and supposed crypto quant-trading fund), and numerous related entities have many pounding the table for government regulation, insisting the US government lead the way.
Ye of too much faith.
Before demanding that the US government take on responsibility for safeguarding private forms of money, perhaps we should consider its mismanagement of taxpayer money.
In 2020, the US government estimates it made "improper" (fraudulent) payments of $43 billion for Medicare and another $86.5 billion for Medicaid. That same year, the Pentagon managed to balance its books only after making $35 trillion in "accounting adjustments"— the kind you should not attempt on your tax return.
This is the entity investors should look to for financial guidance and protection?
Its own financial mismanagement aside, there's plenty of reason to doubt the US government's willingness and ability to substantially disrupt crypto scams, large or small.
I suspect Harry Markopolos would agree.
In his book No One Would Listen, Markopolos describes his multiple in-person attempts to warn regulators about Bernie Madoff's then-ongoing Ponzi scheme. According to Markopolos, government regulators and bureaucrats were unable to comprehend his mathematical proof demonstrating that Madoff's alleged portfolio required him to own more options than existed.
This was just one of many arguments levied by Markopolos.
But you know what happened next: the regulators ignored him, and investors were swindled out of approximately $60 billion.
The US government had everything it needed to stop Madoff before he became a household name.
But what about when a previously honest businessman suddenly breaks bad? What does the government do?
Well, during the crash of 2008, John Corzine—CEO of MF Global—raided an estimated $1.6 billion from clients' segregated accounts.
His prison sentence?
Zip. Zilch. Nada.
Perhaps coincidentally, a few years later the US and every other G20 nation adopted the Financial Stability Board's bail-in scheme allowing Global Systematically Important Financial Institutions (SIFI) to seize customer funds in efforts to prevent bankruptcy.
That's right: the US and other governments formally adopted a policy allowing "special" financial institutions to use customer funds to pay off their failed bets.
FTX has rapidly accelerated the timetable for discovering whether or not crypto exchanges, crypto trading firms, crypto hedge funds, so-called "stable" coins, and the like are Global SIFIs.
It's necessary to have standards and a system of rules for markets to function. But it's clearly questionable that the US government is seriously interested in or capable of protecting you.
In today's legal and political climate, regulations are designed to entrench the established players within an industry and shield them from competition—especially from talented and ambitious upstarts.
In finance, the little guys fear getting whacked for not having the proper disclaimers on their content (you know, the ones pretty much everybody skips past on podcasts and videos).
Big guys only seem to fear regulators after getting caught screwing people out of billions. Punishments seem to be determined by weighing public outcry and the egregiousness of someone's behavior in relation to the size and recipient of their political contributions.
The cherry on top is regulatory capture.
That's when regulatory agencies become controlled or unduly influenced by key players within the very industry they're tasked to monitor.
Regulators put in their time at government agencies and then land cushy gigs at private firms they once "regulated." Build relationships within the government and call on them once working in the private sector—that's the playbook. And when agencies need experts to help them formulate and enforce regulations, where do they find them? In the private sector they regulate.
We need to look no further than FTX and the Commodity Futures Trading Commission (CFTC).
On November 2, 2021, it was announced that former CFTC Commissioner Mark Wetjen joined FTX US as its head of policy and regulatory strategy.
On September 1, 2022, it was announced that former CFTC Commissioner Jill Sommers joined the FTX derivatives board, expressing a desire to make FTX US Derivatives "the most well regulated digital asset exchange in the world," promising to work closely with the CFTC and other regulators.
On November 11, 2022, FTX, FTX US, and Alameda Research filed for voluntary Chapter 11 bankruptcy.
Neither Wetjen nor Sommers blew the whistle.
Neither resigned in protest.
Publicly available information suggests that both Wetjen and Sommers went down with the ship. If true, two former CFTC commissioners had a combined 445 days as insiders before the FTX empire filed for bankruptcy.
Demands for new regulations should be accompanied with equally vigorous demands for competent regulators.
New legislation must also be anticipatory, not merely reactionary.
Existing laws must be enforced.
There's legitimate danger in the illusion of safety.
I hate to be the bearer of bad news, but… in the eyes of the government, you, dear reader, are an acceptable casualty if your suffering preserves the status quo.
Nobody is coming to save you.
You're on your own.
If you still wish to invest in crypto, here's a "regulation" you can self-impose that will better protect you than any government regulation:
Get your coins off the exchanges.
Hold your crypto in cold storage—or accept your fate as an unsecured creditor should your exchange become insolvent.
Assume your exchange is leveraged. Assume every asset left on an exchange has been gambled in one form or another. Think of your exchange as a high-risk hedge fund in disguise.
Assume that stable coins are anything but.
Here's an actual quote from the latest Tether (USDT) attestation statement:
"The valuation of the assets of the Group have been based on normal trading conditions and does not reflect unexpected and extraordinary market conditions, or the case of key custodians or counter-parties experiencing substantial illiquidity."
Translation: "We're stable, but we make no promises to remain so if and when things get unstable."
Crypto investors would be well served to consider what might happen to their specific coins or exchanges, if certain "stable" coins get wobbly. They should be. There's evidence of significant ties between FTX, Alameda Research, and Tether.
While the FTX collapse ripples through the crypto sphere, many investors who got burned—and those who managed to escape with profits—ponder their next moves.
Obviously, you'll have to figure out what's best for you.
There's no shame in moving to cash while we wait for the FTX situation to unfold—including the ramifications at traditional finance institutions.
Crypto investors would benefit from pondering where else they can generate crypto-like returns without encountering the numerous "uncertainties" (to say it politely) of the crypto markets.
The answer seems clear: speculating in a similarly volatile sector of the stock market—but one that's based on tangible reality: natural resources. That's commodities, including food, energy, and mining (gold, silver, uranium, copper, lithium, etc).
Resource speculating should appeal to data-driven and dispassionate investors.
The mining industry is largely meritocratic. Mining is expensive and capital intensive. Inexperience, poor planning, and poor execution are punished quickly and severely. The smart money always follows serially successful mine-finders and operators.
In contrast, the barrier to entry in the crypto sphere is exceedingly low. Hype and hope are seemingly the primary outputs from most crypto projects—very little of tangible value. Coins will rise 10x "out of nowhere" due to marketing campaigns.
There are exceptions, but that appears to be the recipe for "success" in crypto. Any changes made as this process is repeated need only be superficial, not substantial or significant.
In a few short weeks, a copy-and-paste coin can be hyped into perceived importance with clever marketing. But unless you're a world-class cryptographer or coding wizard, you have no way to independently verify claims associated with a given crypto project.
Code can be replicated. Valuable mineral deposits can't.
Mines can be visited. Miners extract resources that can be touched, counted, weighed, and measured. They have contractual obligations to deliver resources used to manufacture tangible goods in the real world. There's zero doubt about the "use case" here.
It generally takes years to develop a profitable mine. You don't need to be a PhD geologist to read the bottom line in a mining report. You don't need an MBA from Harvard to determine if a miner is succeeding or failing.
Of course, scams exist in the resource sector. Mark Twain famously defined a miner as "a liar standing over a hole in the ground." But that's mostly on the exploration side of the business. Once a mine is up and running, quarterly financial reports are reasonably reliable indicators of how it's doing.
The advantage of resource speculating is that investors gain access to volatility, while greatly reducing their exposure to the unpredictable whims of marketing efforts.
FTX proves that this point cannot be understated.
We all like to think we're too smart and clever for marketing gimmicks, but nobody—and I do mean nobody—is immune to the peculiarities of human psychology.
Peer pressure and the fear of missing out (FOMO) impact us all.
For decades, Sequoia has been the name in venture capital. Its $213 million investment in FTX went to $0.
A big, fat goose egg.
But that's not the most embarrassing bit: that distinction would go to Sequoia's gushing puff piece about FTX and its CEO, Sam Bankman-Fried.
Sequoia was not alone. Here's a partial list of other prominent firms who invested in FTX:
Legendary investor Paul Tudor Jones invested in FTX.
It's easy to mock them. But it's wise to learn from them.
Shortcomings in human nature and the allure of crypto undoubtedly contributed to a serious lack of judgment by some of the most experienced and savvy investors in the world.
Watch certain TV networks at two in the morning and you'll find former A-list celebrities (often decades removed from their prime) touting precious metals bullion and IRA investment schemes. Watch the Super Bowl and you'll see current A-list celebrities trying to make you feel like an idiot for not investing in crypto.
Well-funded mining companies can drop low six-figure sums to become the headline sponsor of a mining conference. Crypto companies spend tens of millions for the naming rights of NBA arenas.
This kind of stuff impacts everyone, even the best of the best.
The easiest way to avoid drinking the Kool-Aid is to put down the cup… or never pick it up in the first place.
You won't find many flattering headlines and fawning commentary on the old boob tube about resource speculators.
If such off-the-radar opportunities excite rather than disappoint you… well, you're probably in the right place.
There's breathing room in resource speculating. You'll be ignored by most other investors and mocked by the rest. This gives you the mental space to be cold and calculating.
The numbers show that you can achieve outsized returns by investing in the right miners. You can make plenty of money without even touching exploration companies—but even when you swing for the bleachers there, you're not competing with the biggest funds on Wall Street.
Disciplined resource speculation isn't gambling. It requires calculated risks, not wild bets.
To help decide if resource speculating is right for you, it might help to consider two key questions: where is the economy now; and where is it going?
For decades, politicians, bureaucrats, and central bankers have printed money in response to every problem. Inflation has gotten so bad that even the rigged CPI numbers are ugly.
We're currently witnessing significant layoffs in tech. Mass layoffs across all sectors are likely to follow.
Governments have racked up debt at unsustainable levels. Central banks engage in shenanigans with their balance sheets and interest rates.
A spike in interest rates could leave some countries with debt-servicing payments (interest only, not the principal) in excess of tax receipts.
Even the US faces a legitimate risk of a sovereign debt crisis. By all appearances, the brake lines have been cut.
We'd be lucky to have a stagflationary recession. A full-on depression may be in the cards.
But it all bodes extremely well for gold and silver miners.
At the same time we test the limitations of the fiat money system, politicians and bureaucrats are increasingly hostile toward fossil fuels. For better or worse, the green energy agenda doesn't seem likely to go away anytime in the near future.
You can complain about proposed policies all you want, but doing so won't change much.
So why not profit from them?
Uranium is the clear winner in the making here. (For those interested, here's a primer.) After the recession, key industrial metals like copper look poised to rally for many years to come.
The cyclicality of the global economy brings (relatively) predictable volatility—a necessary ingredient for extraordinary capital gains.
Key indicators point to a bull run ahead for commodities in general and critical metals in particular. But you can't just go out and buy them all. There's a lot of hype about nickel, for instance, that may lead to some poor investment decisions.
Like everything in life, successful resource speculation is much easier said than done.
Understanding the macro setup isn't worth much if you invest in a company working on the wrong patch of dirt.
Certain CEOs, mining directors, and other executives are not to be trusted.
Political and/or jurisdictional risk demands serious attention when resource speculating. Some governments seem to enjoy using bureaucracy to interfere with mining operations, while others like to flat out steal them.
As with all investment opportunities, there are intentional acts of deception, honest mistakes, oversights, acts of God, and plain old bad luck… but with proper due diligence, it's possible to regularly achieve outsized returns.
Whether you invest in crypto or mining stocks, it's unlikely that the government will prevent you from making a regrettable decision. But minimizing your exposure to the crypto industry's collective billion-dollar marketing budget and mass psychological hacks seems like a reasonable way to improve your odds of achieving merit-based returns.
Equities (general stocks) and commodities tend to be contracyclical. Equities have been on a ripping bull for decades. The pendulum is visibly turning back. While most investors panic, resource speculators will be positioned to profit.
As I say, invest accordingly.
By Kyle Johnson, for The Independent Speculator