When Leverage Goes Wrong

In his 1926 book, The Sun Also Rises, Ernest Hemingway’s character responds to the question, “How did you go bankrupt?" by saying, “Two ways. Gradually, then suddenly.”

Almost 100 years later and the quote still works. The recent story of FTX is evidence of that.  Here is a brief history:

On October 21, 2021 this article was on CNBC: Crypto exchange FTX raises $420 million from 69 investors, in meme funding round. The company was valued at $25 billion, and run by a notably intelligent 29-year old with an estimated net worth of $22.5 billion.  For my readers that have no idea what FTX is or does, the article notes:

FTX is one of the world’s largest digital currency exchanges, competing with the likes of Coinbase, Binance and Kraken. It specializes in derivatives and trading on leverage, the use of borrowed funds to amplify trades.

Crypto currency derivatives? Trading on leverage? Meme funding round? I don’t see what could go wrong.

11 months later on Sept. 21, 2022, this article was on CNBC: FTX in talks to raise up to $1 billion at valuation of about $32 billion, in-line with prior round.  Despite the volatility in the crypto markets, FTX and its CEO, Sam Bankman-Fried, were considered safe bets.   

Then, just three weeks after the previous article, CNBC writes: Sam Bankman-Fried steps down as FTX CEO as his crypto exchange files for bankruptcy

From $32 billion to $0 in a matter of days.

The lessons here go beyond crypto currencies. Financial history is filled with examples of smart people getting rich and then losing everything.  Archegos, Long-Term Capital Management, and Amaranth all have terrific Wikipedia pages explaining how some of the most brilliant investors quickly lost billions of dollars by failing to manage the risk.

Don’t repeat their mistakes. Keep it simple, avoid leverage, and never get greedy.