The important lesson from FTX on risk mitigation


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The important lesson from FTX on risk mitigation

Over the past decade, many have been seduced by the perceived invincibility of tech entrepreneurs whereby the mere promise of game changing technology, absent of any sustainable business plan, was good enough for billions of dollars to be poured into aspirational and ambitious ventures. 

In a matter of months, we have seen the implosion of FTX, the sudden fall of Twitter and with it a decline of Tesla as the once golden touch of Musk is now being scrutinised by the very same people that once called him a genius. 

The implosion of FTX looks like a remake of a “movie” we saw four years ago. Theranos Inc. was an American privately held corporation that was touted as a breakthrough health technology company, where the founder took a revolutionary idea, galvanized support and investment, then subsequently mismanaged the business to the point of fraud and ultimately losing millions of dollars for investors. 

At its peak, Theranos was valued at $6 billion. In the aftermath of its incredible fall, investors lost over $600 million. FTX was worth $32 billion as recently as Jan 2022 with over one million users and was the third largest cryptocurrency exchange by volume. When the dust settles, investor losses are expected to be over $1.8 billion. 

There were enough high profile investors in both Theranos and FTX that would give credibility to the average trader on Wall Street. Names like George Schultz and Henry Kissinger for Theranos and Temasek Holdings for FTX. 

There is an irresistible allure about technology start-ups that promises to change the world. Other than the opportunity for quantum returns, there’s the desire to be part of a revolution; especially one with a promise of delivering game changing social impact.

Aside from FTX, the entire tech industry has seen a decline in valuation that is both stunning and cautionary. From its peak in 2021, not one of the 15 most valuable U.S. tech companies has generated positive returns in 2022.  Meta’s market cap has contracted by over 70% from its highs, wiping out over $600 billion in value this year. In total, investors have lost roughly $7.4 trillion, based on the 12-month (Nov 21 – Nov 22) drop in the Nasdaq. 

What can we learn from these costly failures? 

History will tell us that trusting inexperienced entrepreneurs with billions of dollars and minimal supervision is dangerous.

Another important history lesson that is worth repeating; high returns comes with high risks. Taking risky investments is a hallmark of capitalism and without it there is no progress. But risk taking should come with appropriate risk mitigation measures. It must always be coupled with sound risk management.

In the private wealth management industry, most of the clients are business owners where the family fortune is intricately tied to their business fortune. Risky investments that fail spectacularly at the wrong time can cause generational damage. But if risky investments are inevitable, how can the risk be mitigated? By offering a simple solution with the use of insurance; an effective tool to provide liquidity when liquidity is most needed to replace the value of bad investments. 

Risk mitigation is such a constant part of our daily lives that we don’t even know it’s there. For example, you would not think of driving a car without car insurance. Did you know that an average driver only has 3-4 car accidents in a lifetime?  But being insured during one of these accidents could potentially save tens of thousands of dollars so we gladly pay the annual premiums to mitigate this risk. The key takeaway here is the bigger the risk, the more important it is to mitigate. What risk is bigger than your life? What is your life worth to the people close to you? This is the question to answer when we examine one’s life insurance needs. The risk of a sudden fatal absence without a plan to mitigate this risk can place unnecessary burden on families and loved ones.

There will always be another FTX because memories are short whilst the pull of investing in the next Apple is relentless. This is not to say that investing in tech is bad. But falling for the allure of a quick return without examining the sustainability of the business AND taking the appropriate risk mitigating measures is foolish. Taking risks is part of life. So is planning for such risks in a responsible way. The uncertain nature of risky investments says there will always be another FTX. But maybe the lessons learned can be better applied; especially the important lesson of risk mitigation.