FTX. And an example of why diversification matters

November 18, 2022

The fact that the new bankruptcy CEO of FTX pointed out, in his first public missive, that he is "over the age of 18" should tell you a lot about what you need to know.

There is news everywhere, which you can read. It's abundantly clear Samuel Bankman-Fried and his band of buddies had no understanding of their own firm. But they *did* figure out that if you draft up some complicated-looking spreadsheets, say things confidently over and over, and have cash to kind of back up those spreadsheets, a lot of people will believe you. Even though they also have absolutely no idea what is going on.

Smooth all that over with a good helping of "effective altruism" and pretty soon you're advising the biggest finance companies and most power politicians in the world.

This one is shaping up to be a true beauty.

Let's look at a few things that are relevant to you from this debacle.

1. You can just sit and watch in investing. You don't have to participate in manias, and you don't have to react. This is different from, say, running a business with competitors. If competitors do things, you probably have to have some reaction.

2. Investing in currency is not investing. It's speculating. Currencies are transfer agents. Some of them, like the Swiss Franc, have a long history of stability. But however they are managed, they do not produce anything intrinsically. Instead they allow other pieces of an economy to operate in a more friction-free form. In the case of crypto, much of that friction-free enabling is in the form of illicit transactions, shadowy state activity, and other wonderful things.

3. The computer science behind crypto is non-trivial. If investors cannot understand an Excel spreadsheet, the chance that that they understand what is happening in crypto approximates zero. This applies to the celebrities, venture capitalists, large American financial institutions, economists, and politicians who all piled into the hype. It is dangerous as an investor not to understand the underlying mechanisms.

4. What is somewhat incredible in all of this is that Bitcoin is still trading about $16,000 / share. Or coin. Or whatever their imaginary construct is. (Note how they quote it in U.S. Dollars - the irony). So a lot of people still believe. Remember that many Soviet prisoners in the Gulag still believed in Stalin. While they were in the Gulag. Think about this when you are frustrated that someone won't change their mind.

Amidst all the negative news, there is an asset class going ok this year. It's a part of most One Day In July portfolios, and it shows why diversification matters. Here's the total return of large-cap value, year-to-date:

This is also nominal dollars, meaning it doesn't account for the loss of value in inflation. But large capitalization value stocks are break-even this year, and that is after a huge run-up that peaked right around December 31st last year.

So are we buying more now? Generally no. We're off to other areas where investors are handing over their securities at lower prices.

Dan Cunningham

<sup>1. Appendix A. Here are some FTX links you might enjoy:
Vox: SBF fake ethics
Fortune: The Excel balance sheet
The bankruptcy filing
2. The graph above is Vanguard high-dividend yield large-cap ETF, 1/1/2022 - 11/16/22</sup>