There are many things we can learn from the FTX debacle. First, and most importantly, FTX’s core problems had little to do with crypto. Fraud, mismanagement, hubris and lack of board oversight — among other things — created an unnecessary crypto crisis where countless crypto investors lost their money. The other big lessons to learn are the dangers of centralization and fragility.
One of the driving forces behind crypto’s adoption is decentralization. As Adam Sharp detailed on bitcoin’s 10th birthday, bitcoin was created in the midst of the financial crisis. And part of that crisis was an interconnected, centralized banking system that needed to be bailed out by the federal government.
Bitcoin was created, in part, to solve the problems caused by an economic system dominated by large centralized entities. By creating a decentralized system, the hope was that the failure of large powerful actors couldn’t bring down the system — or that the system would prevent institutions from gaining the type of power that could either exert undue influence on or damage the ecosystem.
But the fully decentralized system hasn’t materialized yet. And for good reason. Crypto in its purest form, including bitcoin, is NOT user friendly (yet). It’s hard to store on your own. It’s hard to transfer crypto. If you lose your keys, you lose your crypto. And systems that are difficult to use don’t attract users. So centralized exchanges (CEXs) were created.
CEXs made crypto easy to use, store and trade. That drove adoption, which in turn created market liquidity that allowed crypto to grow.
It’s ironic. A decentralized system needed some centralization to succeed. But that centralization has created weak points in the crypto ecosystem.
Since 2012, hackers have managed to steal almost $3 billion from exchanges. In October, hackers breached Binance and stole $570 million worth of crypto. In January, hackers stole $34 million from Crypto.com.
Hacking isn’t the only problem with CEXs. Many exchanges have grown so large that they influence markets. In the first five days after coins list on Coinbase, they average 91% gains, according to Coindesk. That simply doesn’t happen on other exchanges. And it’s not healthy for the ecosystem (though it is useful to know as a trader). Listings on other crypto exchanges don’t do that. That’s too much control in the hands of one exchange. And it shouldn’t happen in a properly functioning market.
Loose financial controls are another problem. FTX crumbled because it moved customer funds and assets in and out of the system like it was company money that could be recklessly spent or invested. It was only a matter of time before FTX lost it all.
In an effort to prove that it was run better, Binance hired the accounting firm Mazars to “audit” its reserves. The report Mazars produced just created more FUD (fear, uncertainty and doubt). Mazars refused to endorse the methods used to generate the report. And the backlash to the report was so fierce that Mazars stopped working with ALL of its crypto clients (for now).
Sorting through FUD is a big — and annoying — part of the crypto ecosystem. Binance-associated FUD is extremely scary, though. Binance falls in the “too big to fail” category. If Binance falls, it could bring down the entire crypto system. And there will be no government bailouts for Binance. Crypto doesn’t have the same friends in government that banks do.
That points to the fragility of the system. CEXs create giant single points of failure — the exact opposite of what crypto was created to do.
Better regulations, transparency and accounting principles could solve some of these problems. But that requires collaboration, consensus-building and common sense on a scale that we rarely see these days.
Fortunately, a better system already exists in the crypto ecosystem. They’re called decentralized exchanges (DEXs). DEXs, much like crypto, were a bit unwieldy when they started. But they’ve become easier to use and more popular over time. The top four DEX sites had almost $2 billion in trading volume over the last 24 hours, according to CoinMarketCap.
DEX platforms essentially operate as peer-to-peer trading environments. The people trading crypto maintain custody of the assets. The trades are executed using smart contracts that execute automatically. DEXs typically offer lower trading fees. And because investors maintain control over their assets, they don’t have to worry about what happens when an exchange falls or goes out of business.
DEXs aren’t as easy to use as CEXs — though it’s getting better. But they do eliminate many of the pain points that CEXs have. We currently don’t have any exposure to DEXs in the First Stage Investor crypto portfolio. Let’s change that by adding Uniswap (UNI).
Uniswap is currently the largest DEX by trading volume, according to CoinMarketCap. It focuses on the trading of Ethereum-based tokens (ERC-20). It launched in November 2018 and surpassed $1 trillion in lifetime volume earlier this year. And it had almost $630 million in trading volume in the last 24 hours.
That $630 million pales in comparison to large CEXs like Coinbase, which had almost $2 trillion in 24-hour trading volume. But it’s significant enough that investors should have exposure to it — especially given the problems CEXs are facing.
Investors can also trade NFTs on Uniswap. Uniswap acquired NFT aggregator Genie in June and began selling NFTs in November. I’m not sure how big this business will become, but it’s a good sign that Uniswap is trying to set itself up for future growth and success instead of just relying on what it’s been doing since 2018.
UNI is the governance token for Uniswap. And it has had a wild three months.
Despite the turmoil in the markets, UNI is only down 3.27% over the last 90 days. And it managed to gain significant ground for part of that time. That’s a good sign that UNI is capable of weathering significant storms.
In the midst of a bear market, gaining exposure to multiple crypto sectors is critical. It spreads your risk out — and gives you multiple chances of gaining exposure to the next crypto sector that takes off. In a market as volatile as crypto, this is critically important.
And with CEXs showing signs of weakness, now is a pretty good time to add a DEX crypto position. Uniswap (which can be bought on Coinbase) fits the bill nicely.
Rules of the Road
Investing in a bear market is tricky. It is likely that the market will go down further from here. But it’s important to be opportunistic. So if you have capital to invest — and you’re psychologically and emotionally willing to enter what promises to be a highly volatile market — here are some guidelines to follow.
- Do not invest money you can’t afford to lose. The markets are in for a rough ride. And if you can’t afford to lose the money, don’t risk it.
- Focus on projects with strong use cases.
- Look for teams or communities that are active and committed to their projects.
- Always enter a position using dollar cost averaging. That means buying a small amount each week rather than buying your entire position at once. That way, if prices continue to fall, you lower your overall acquisition cost.
- Don’t try to time the market perfectly. Nobody can. And I believe this bear market will be around for several months. So if you want to wait, that’s perfectly okay. But when you do invest, make sure you utilize dollar cost averaging to buy into the market.
- Diversify your crypto portfolio. From a percentage standpoint, bitcoin and ethereum should be the biggest investments in your crypto portfolio. But you need exposure to a much broader and more diverse set of coins to take advantage of the full upside of the crypto markets. Bear markets are a good time to diversify your portfolio and increase exposure to different crypto sectors.
Remember, investing in crypto is risky. Investing in a crypto bear market carries even more risk. Less than 5% of your overall portfolio should be invested in crypto. That said, I believe UNI provides an attractive risk-reward ratio.