FTX and the Blackstone Redemption Freeze | Our Thoughts

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It’s been a tough couple of months for some investors. Just a few short months ago, FTX was on top of the world. Widely regarded as one of the preeminent investment options in its space, FTX commanded huge portfolios and looked forward to a seemingly bright future.

Now, not so much. The crypto giant became the poster child for what some commentators have dubbed crypto’s “Lehman Brothers Moment,” its founder now faces federal charges, and regulators have wasted little time swooping in and threatening to bring the hammer down on the crypto space.

Meanwhile, a smaller story was brewing at Blackstone’s Breit. While the Blackstone redemption freeze situation is hardly a fiasco on FTX’s level, it’s a lot more relevant to real-estate types. Some commentators who watched Blackstone pull up the drawbridge quickly took to Twitter to point fingers at Blackstone’s leadership and suggest that an FTX-style meltdown was coming. It’s true enough that, for Blackstone, the situation could be better: Breit’s investors are spooked, some commentators worry what the Breit run signals for the rest of the REIT space, and so forth.

But we think there’s critical differences between the FTX and Breit situations, so today, we figured we’d share our thoughts.

What happened to FTX?

Start at the beginning. FTX is (was?) a crypto exchange. That isn’t very remarkable, because there’s lots of digital marketplaces where users can trade crypto assets for either other digital assets or government currencies. What is remarkable is that Sam Bankman-Fried’s empire attracted a massive user base very quickly by promising lofty returns, flaunting celebrity endorsers like Shaq and Tom Brady, buying naming rights for the Miami Heat Arena, and riding a potent cocktail of pandemic-bull-run internet hype and hefty VC buy-in all the way to an eye-watering $32 billion valuation.

But it didn’t last. In early November, CoinDesk published a critical article pointing out that FTX’s sister company — a trading firm called Alameda — was using FTX’s native token, FTT (think of it like Ethereum’s ether or Binance’s BNB), to prop up its balance sheets. While commentators were quick to point out there’s nothing flatly wrong with doing that, it did put some giant red flags in FTX users’ field of view. First, FTX and Alameda’s value didn’t depend on any trustworthy, external indicators like traditional currency or other cryptos. Instead, all their assets were denominated in, and all their liabilities collateralized by, a currency that the guy who created both companies literally invented “from thin air.” 

Second, Alameda’s giant FTT stockpile raised questions about where, exactly, FTX customers’ deposits were going.

That made both companies’ positions more precarious than investors thought. Plus, it implied that FTX and Alameda were even more closely connected than most users previously suspected. While the chain of reasoning varies depending on whose Twitter commentary you believe, the Tl;Dr was: those revelations convinced plenty of users that FTX hid massive undisclosed risks and gambled with customer deposits.

Predictably, everything hit the fan. The liquidity worries the November revelations teed up materialized, ironically, when investors started pulling their assets and the panic snowballed into a bona fide bank run. When the smoke cleared, investors had hauled billions out of the exchange, a buy-out offer from Binance had been floated and scuttled, and FTX wound up filing for Chapter 11.

In some ways, the catastrophe wasn’t too surprising. Plenty of other crypto schemes have turned out to be worthless or fraudulent. (Anyone remember Terra?) But, importantly, when those schemes collapsed, some in the crypto community pointed to Bankman-Fried — and FTX — as the white knight/robber baron who could parachute in to save the system.

What happened at Blackstone?

Around the same time, a story that looked similar — but ultimately proved to be very different — was playing out at Breit, Blackstone’s vaunted non-traded REIT. Breit opened its doors only a half-decade ago, but quickly attracted a large investor base and frothy valuations by making strategic plays aimed at core assets while dodging much of the pandemic-era dip by staying diverse and limiting exposure to office assets. Over the last few years, Breit’s investors have done pretty well for themselves, earning double-digit annualized returns.

Problem is, some REITs have had a hard couple of months. Rate increases, dwindling demand for high-value assets, and generalized economic malaise have all got their share of finger-pointing, but Breit actually compared pretty favorably to most of its competitors. Nevertheless, some investors decided they wanted out. When investors started taking their money out, Breit faced a problem: because it relies on investor contributions to purchase the assets it ultimately uses to generate returns, it doesn’t just have all that cash on hand. So if too many investors ask for their money back at the same time, Breit gets to enjoy a liquidity crisis.

One Reuters columnist described the problem pretty aptly:

“For any investment fund that takes money from investors to plow into hard-to-sell assets like property, the ultimate fear is that clients all ask for their cash back at once. If a fund can’t meet the withdrawals from cash or more liquid assets, it would have to offload investments at fire-sale prices to get money as quickly as possible, leading to a vicious feedback loop.”

Fortunately for Blackstone, they’d taken precautions against just that scenario by including withdrawal limits in the investor agreement. On one hand, Blackstone irked some investors, pulling up the drawbridge at the critical moment and effectively locking investors into what they thought might be a losing investment. On the other hand, Blackstone’s stem-the-bleeding tactic was totally above-board: it was literally written into the investor agreement. Plus, it probably saved Breit from an FTX-style meltdown. 

Why does all this matter?

What those two headline-grabbing developments have in common is liquidity crises. There’s a plausible world in which FTX could have stayed alive long enough to solve its PR problem (though, of course, definitely not the fraud that was subsequently revealed). Instead, users raced to withdraw their investments as quickly as possible — and FTX found itself bankrupt. What started as a maybe-solvable PR problem rapidly became a definitely-unsolvable liquidity problem.

Blackstone, on the other hand, was smart enough to foresee and to plan for liquidity crises on the front end. So when the bank run came for them, they managed to survive it. Some investors might not be happy that Blackstone closed the gates — especially when anxieties about rising rates are already spooking a decent number of real-estate types — but Breit will almost certainly live to fight another day. That was undoubtedly the right move. Blackstone’s secret sauce, at the end of the day, isn’t all that secret: they have a pretty unassailable capital stack. And one reason for that is that they’ve taken precautions against bank runs — precautions that might irritate investors during downturns but ultimately protect everyone’s investments by not having to sell assets at a loss.

As for the broader discourse the FTX and Blackstone situations sparked, we have a couple of thoughts. First, the situations might look similar on the surface, but in reality, they’re very different. FTX scammed a ton of people out of their life savings. There’s no redeeming that narrative. But Blackstone pulled up the gates to save the castle, and in doing so protected their investors’ money from a potentially-fatal bank run. Liquidity crises pose a real risk; insulating your investments from them is critically important. If your enterprise folds the moment a few investors decide to take their cash elsewhere, everyone loses. Still, Blackstone didn’t escape criticism entirely. Capital lock-in is an effective solution to liquidity crises, but it can pose PR problems. ‘Pull up the drawbridge’ is a good plan, but so is having a great PR team that keeps investors abreast of the situation.

From an investor perspective, though, both scenarios have proven frustrating. And that underscores how critical it is to perform thorough due diligence before you give somebody your hard-earned cash.

Whether or not FTX set out to defraud anyone is a question for the courts and historians, but whether someone was trying to exploit you only matters so much when you’ve lost your life savings. Investing is always risky business, but the FTX collapse illustrates a point we’ve been making about crypto for a while: it’s the Wild West out there, and while some crypto investors will doubtless make a killing, others will simply get killed.

Contrary to some of the more out-there suggestions we’ve seen on Twitter, Blackstone simply didn’t do anything to rival FTX’s misfeasance. Pulling up the gates on investors might be a tough look, but the move made sense. And it comes with a lesson for investors. Redemption freezes hurt, but it was pretty much Blackstone’s only out. Private real estate investments only work if you use investor contributions to buy, well, real estate. And real estate, as we all know, is not the most liquid asset in the world. Letting every investor redeem their investment whenever they wanted would be a recipe for disaster.

What’s more, everything Blackstone did was perfectly okay by the terms of the investor agreement. That agreement is there to protect investors, and that’s exactly what it just did. But that doesn’t mean investing with Breit was the right choice for every investor. You should understand a business before you give it your money (especially if it requires long-term capital commitment into illiquid assets), read contracts before you agree to them (especially when they limit your redemption rights), and don’t be afraid to walk away from investment opportunities that don’t fit your needs. For investors okay with some illiquidity, Breit was a great deal. For those without that illiquidity tolerance, the terms and conditions should have been enough of a red flag.

Our bottom line:

We think private real estate is one of the best asset classes out there, and we’re thrilled to run a company whose mission is making it accessible to as many investors as possible. But that’s not to say every investor should throw their entire portfolio at one real estate company without reading the terms and conditions carefully. One of the benefits of private real estate is that it unlocks impressive cash flows that fuel the kind of shareholder distributions that could beat most dividend stocks with one arm tied behind their back. But one limitation of that approach is that it works best when you’re in for the long haul. That works great for retirement accounts, but isn’t such an ideal fit for investors who can’t withstand some illiquidity.

And whatever the general illiquidity risk, every fund has slightly different rules and nuances to consider. Investors should always read the fine print before writing any checks. What’s more, while we think private market funds can offer pretty world-beating risk-adjusted returns, that’s not to say they’re bulletproof. Just like bull runs can mint millionaires overnight, giving retail investors access to private funds does, candidly, come with its own risks. Well-managed funds have plenty of tools they can use to contain that risk, but it’s just one more reason you should know what you’re getting into before you, well, get into it.

What happened at FTX, on the other hand, is an appalling injustice that everyone in the investing community should work hard to prevent from happening again. But scandals like that should also instill investors with some resolve. Crypto is a highly speculative investment that could make sense in certain portfolios — but only in measured proportions, and in situations where the rest of the portfolio is well-insulated from existential risks. Throwing all the eggs in one basket was never a good idea, and while it’s a tragedy that FTX’s haircut special hurt people, we hope it also helps others avoid similar pitfalls in the future.

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