4 Lessons for Crypto Investors from the FTX Collapse: 'There Is No Such Thing As a Free Lunch'

After a difficult year for digital assets, many investors were blindsided by the recent collapse of cryptocurrency exchange FTX. Customers are still waiting for answers about an estimated $1 billion to $2 billion of missing funds.

As FTX enters bankruptcy protection, the future of the company and investigations into the vanishing assets are in limbo. However, experts say there are key lessons for crypto investors to take away from this situation.

"The FTX collapse is a harsh reminder that there is no such thing as a free lunch when trying to make a quick buck in a still fairly new, unregulated financial industry," said certified financial planner Jon Ulin, CEO of Ulin & Co. Wealth Management in Boca Raton, Florida.

It's been a tough year for cryptocurrency investors, but you may still owe taxes on your gains. Credit card balances are up 15% as Americans fall deeper into debt. The Biden administration is warning of a rise in student loan defaults.

Ulin advises that people should only invest "what they are willing to lose 100%," as in Vegas. They should also use discretion and skepticism when weighing assets and related products pitched by pro-athletes, celebrities, and media personalities.

1. Don't put all your eggs in one basket.

2. Diversify your investments.

3. Don't put all your faith in one company.

4. Do your own research.

Kevin Lum, a CFP and founder of Foundry Financial in Los Angeles, said that about 50% of his clients hold crypto in some form. He added that he works with younger investors and that crypto is becoming more popular with this demographic.

He said that although he doesn't think that clients necessarily need to reduce their exposure, they do need to understand where digital currency is held and the possible risks associated with keeping assets in that location.

Lum believes that the collapse of FTX will ultimately benefit traditional finance companies like Fidelity who are venturing into the cryptocurrency space. He believes that these companies come with a certain level of trust and credibility.

Earlier this month, Fidelity Investments announced plans to launch a commission-free crypto product, allowing investors to buy and sell bitcoin and ether. This move by Fidelity is seen as a major step forward in the mainstream adoption of cryptocurrencies.

The recent collapse of FTX has renewed interest in cold storage for digital currency, which would make it less susceptible to hacks. However, this would also make assets less liquid and harder to trade quickly.

Investing experts generally agree that holding a large percentage of any one asset can be risky. This applies whether you're investing in stocks, cryptocurrency, or other assets.

George Gagliardi, a CFP and founder of Coromandel Wealth Management in Lexington, Massachusetts, believes that diversification is always important. By investing in a variety of assets, you can help protect yourself from the risks associated with any one particular investment. This strategy can also help you achieve your financial goals by providing you with a more well-rounded portfolio.

This year's crypto price crashes were a painful lesson in the importance of diversifying one's investment classes for those who had a very high allocation to cryptocurrencies, according to one observer.

The price of bitcoin has dropped sharply since reaching an all-time high of $68,000 in November 2021. As of Nov. 17, the price had fallen below $17,000, a decline of more than three-quarters.

"The collapse of FTX should serve as a reminder that any company, whether it be a crypto exchange or a more traditional business, can go bankrupt during times of hardship," said Kevin Brady, a CFP and vice president of Wealthspire Advisors in New York.

He said that when weighing portfolio allocations, 5% of a single asset starts to be material, and 10% is very concentrated. Of course, there may be mitigating circumstances for some investors.

Ulin of Ulin & Co. said that even if a financial asset is speculative in nature, it can still play a role in a well-diversified portfolio, albeit in small amounts.

There has been a lot of debate about how cryptocurrency should be classified and regulated. This debate has intensified in light of the recent FTX fallout.

In June, Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced a bill to establish a regulatory framework for digital currency. The bill would classify most digital assets as commodities, such as gold or oil, which would be overseen by the Commodity Futures Trading Commission.

According to experts, the FTX meltdown may spur on discussions about future guidelines and regulations. "I think we're going to see regulations," said Ivory Johnson, a CFP and founder of Delancey Wealth Management in Washington. "And I think these bad business models will go away."

House Financial Services Committee Chairwoman Maxine Waters and Ranking Republican Rep. Patrick McHenry have announced plans for a bipartisan hearing in December to investigate the collapse of FTX.

Although Congress will have the final say on how government agencies can regulate cryptocurrency, Securities and Exchange Commission Chair Gary Gensler is advocating for stricter rules. "Investors need better protection in this space," he told CNBC's "Squawk Box" on November 10.Experts suggest downloading your transaction history periodically, regardless of where you're holding digital currency. This can help you keep track of your finances and ensure that all your transactions are accounted for.

According to Andrew Gordon, tax attorney, CPA and president of Gordon Law Group, gathering reporting documents is one of the most difficult parts of crypto taxes. If an exchange closes down, you will still need records to file your return, he said.

"Just a couple of weeks ago, hardly anyone could have predicted that FTX would be in this situation," Gordon said.

According to him, you will also have a better understanding of your profits and losses by tracking them throughout the year. This will make it easier for you to reduce your expenses with strategies like tax-loss harvesting. He said that this will put you in a much better position when tax time comes.