Key lessons from the Collapse of FTX and the Implosion of FTT

[TL; DR]

- Crypto investors should carry out thorough research on the crypto projects they want to invest in.

- An investor should invest not more than 10 % of his/her capital in a single asset.

- Investors should diversify their crypto portfolio to reduce risks.

- It is safer to keep cryptocurrencies in non-custodial wallets than in custodial ones.





Introduction

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The collapse of FTX, a crypto exchange that was considered a stalwart in the industry, reminds crypto investors about the risks of investing in cryptocurrencies and other digital assets. Within less than a month a once vibrant business, worth more than $16 billion, became insolvent and filed for bankruptcy. This followed a trail of events that started with leaked company secrets and ended with the withdrawal of assets that are worth more than $6 billion within 72 hours.

The focus of this article is not to dwell on the causes of the collapse of FTX nor the events and circumstances that led it to file for bankruptcy but to derive lessons that crypto investors will use for decades to come. Both institutional and retail investors have much to learn if they are to avoid potential risks that exist in the cryptocurrency sector.
Carry out a thorough research on an exchange or cryptocurrency

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The first important lesson derived from the collapse of FTX is that investors should carry out thorough research on a crypto exchange, a DeFi platform or a cryptocurrency they want to invest in. The research should involve several things including understanding the founder of the project, the team behind it and the use cases of a cryptocurrency or exchange.

The reality is that there are hundreds of exchanges which can make it very difficult for the investor to select the best one. However, there are platforms that rank the performance of exchanges. For instance, CryptoCompare gives timely updates of the best crypto exchanges in its reports.

When carrying out the research, it is important to find out when the exchange was established and how it has been performing over the years. It is best to go for an exchange that has been performing well. As an instance, it is better to invest in a crypto exchange that has been in existence since 2013 than the one that started operating in 2020.


Keep your cryptocurrencies in non-custodial wallets

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A non-custodial wallet is a digital wallet whose owner has full control of its private keys. This means that no one else will ever have access to the cryptocurrencies unless the owner gives him/her the private keys. With custodial wallets another party controls your private keys. The wallets you find on exchanges are custodial ones and are not as safe as the non-custodial wallets.

Therefore, if you keep large sums of cryptocurrencies on exchanges you may fail to recover them if it goes bankrupt or there is a hack. Most customers who kept their cryptocurrencies at FTX exchange may fail to recover them.


Limit your investment in a portfolio at a reasonable level

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One of the main pieces of advice about investment in cryptocurrencies is to limit the amount you invest per portfolio to not more than 10% of what you own.

Although the investor has a choice to set his/her target limit per investment, it is important to spread the funds among several portfolios. The reason is that if one of the investments fails you still have the capital to invest in other opportunities. An investor who invested all his/her funds in FTX may lose it all.


Invest in cryptocurrencies that you know

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Another great piece of advice is to spread the investments among various assets. For instance, the investor should invest in several top 10 cryptocurrencies such as bitcoin, ETH and BNB. He/she can also invest in cryptocurrencies within the top 20, based on market capitalization. Such cryptocurrencies have less chance of implosion than the ones outside the top 100 list, for example.

Yes, one should also look for promising utility tokens. Presently, many exchanges have their utility tokens. For instance, the GateChain Token (GT) is a utility token for Gate.io exchange. However, it is not a good idea to invest in any utility token without proper research. You have to research widely to ensure that it has a fundamental purpose to serve. It is very risky to invest in cryptocurrencies which are not supported by valuable products or projects.

It is important to say that, generally, tokens for exchanges are suitable investment assets since they entitle their holders to a share of trading fees or discounts. In some cases, these are traded in secondary markets.


The backing of venture capitalist does not guarantee the success of a cryptocurrency

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Probably, one of the greatest lessons from the collapse of FTX is that the backing of many venture capitalists does not guarantee the success of a token or project. FTX was backed by several big venture capital firms such as Iconiq Capital, SoftBank Sequoia Capital, Lightspeed Venture Partners and Tiger Global Management.

Nevertheless, FTX collapsed despite such backing. What matters the most are the fundamentals of a cryptocurrency, the integrity of the team and its business ethical and governance practices rather than the number of backing venture capital firms. Unfortunately, there was a lack of integrity and ethical leadership in the management of FTX. The misappropriation of the funds is clear evidence of that.


Great marketing effort does not translate to the success of a cryptocurrency

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Another great lesson from the FTX case is that massive advertisement does not guarantee the success of a project or cryptocurrency.
For example, much of FTX advertising was spearheaded by celebrities such as Naomi Osaka - a successful tennis player, Stephen Curry - a renowned NBA star and Tom Brady - a NFL quarterback. This attracted much attention and many customers.

Secondly, FTX sponsored several major events and sporting teams like the Mercedes-AMG Petronas Formula 1 team and Major League Baseball. Such advertisement activities gave FTX customers a sense of security and an anticipation of success and sustainability.

However, the collapse of FTX has shown that investors should not be lured into pouring their funds in a crypto project based on its advertisement and promotional efforts but its vision and fundamentals.


Find out proof of reserves

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One mistake many investors make is to rely on the communication which the team gives about a cryptocurrency or crypto project. The case of FTX, just like that of Terra USD, has shown that some crypto projects give wrong information about their reserves, among others.

Reserves are an important component of crypto projects. Therefore, investors should verify the reserves which the projects say they have. It is also important for the crypto projects to provide proof of audited reserves.

The type of collateral that a crypto project has matters, too. Some crypto projects use their own tokens or tokens of sister projects as collateral. If there is a major change in their fundamentals, the result can be disastrous to the entire project.




Limit the level of debt you have

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It is important to keep a reasonable debt as an investor. Relying on too large leverage, for example, can result in liquidations of your trading positions if prices fall below the threshold. A mistake which FTX made was to lend millions of assets to its sister company Alameda Research. This triggered its downfall.


Conclusion

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The downfall of FTX has given us valuable lessons. For example, investors need to carry thorough research in projects they intend to invest in. They should also limit debts and diversify their portfolios. Likewise, they should invest in established cryptocurrencies and crypto exchanges with proven track records.



Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all cases, legal action will be taken due to copyright infringement.