Can I Get My Money Back? FTX Crypto and Liquidity (4 Video Links)

We’ve all asked this question when buying products and services. If I buy that sweater from Nordstrom’s (“Nordys”, at my house), what’s the return policy? Will the airline allow me to change the travel dates for that vacation without a penalty? How long do I have to return that kitchen appliance for a full refund?

 

Now, think about investing.

 

Investors must manage market risk, consider investment costs, and plan for retirement. However, one of the biggest issues for investors is liquidity.

 

This discussion defines liquidity, and provides examples of liquidity for various investments. The post also explains what happened at FTX, the huge crypto firm, and how a lack of liquidity created investor losses.

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What is Liquidity?

 

Accounting and finance define liquidity in different ways. What is liquidity in finance? It’s the ability to sell an asset quickly, and for a reasonable cost.

 

Liquidity in the stock market

 

What is liquidity in stocks? It’s a good starting point, because so many investors own stocks.

 

Assume that an investor buys 100 shares of IBM common stock on the New York Stock Exchange (NYSE). Market makers- firms that provide a buy and sell price- ensure that there will be a market to sell the stock down the road. Now, you may not like to bid price- you may have to take a loss- but exchanges maintain a market for selling securities.

 

You can sell your stock on any business day that the exchange is open, and you can settle the trade and get your funds in just a day or two. You’ll pay a commission for each trade, and stock trading commissions have declined rapidly over time (some stock trading is now commission-free).

 

The NASDAQ is another large exchange for stock trading. Commodities, precious metals and other assets also trade on markets, for the same reason.

 

Why is liquidity important? Because investors eventually need access to the assets they own, either to fund another purchase (like a home), or to fund retirement.

 

Consumer Protections in Financial Service

 

Financial services companies must meet certain requirements to operate, including regulations around holding customer assets. Here are a few:

 

Reporting to investors

 

If you have cash and securities invested through a firm, the company is required to report your holdings to you (that’s why you get monthly statements).

 

Investment disclosure

 

Many investments, including initial public offerings, must be sold by prospectus, a document that provides extensive detail on the company issuing the stock. A prospectus includes audited financial statements, and a lengthy explanation of why the company is raising funds by selling stock.

 

Custody of investor assets

 

Responsibilities for financial service firms have increased in recent years. Many financial advisors are now categorized as fiduciaries, meaning a person put in a position of trust.

 

Financial service companies cannot lend a customer’s securities to another party without prior approval from owner. These firms also must have an audit performed, and the audit confirms that each customer’s securities are held in custody on the investor’s behalf.

 

Which brings us to FTX and the crypto market disruption.

 

What Happened at FTX

 

This Wall Street Journal article explains what happened at FTX, a large cryptocurrency trading firm:

 

“Crypto exchange FTX lent billions of dollars worth of customer assets to fund risky bets by its affiliated trading firm, Alameda Research, setting the stage for the exchange’s implosion, a person familiar with the matter said.

FTX Chief Executive Sam Bankman-Fried said in investor meetings this week that Alameda owes FTX about $10 billion, people familiar with the matter said. FTX extended loans to Alameda using money that customers had deposited on the exchange for trading purposes. (italic added).

All in all, FTX had $16 billion in customer assets, the people said, so FTX lent more than half of its customer funds to its sister company Alameda.”

 

FTX did not have to follow the same regulations as other financial services companies. Investors don’t have liquidity if the assets are no longer held for them. FTX lent customer assets, lost the money, and has now filed for bankruptcy.

 

The lesson: Crypto investors do not have all the regulatory requirements that protect investor assets. Buyer beware.

Ken Boyd

Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies

(amazon author page) amazon.com/author/kenboyd

(email) ken@stltest.net

(website and blog) https://www.accountingaccidentally.com/

(Image) Frustration, Jason Bolonski