Investing in Innovation with Cathie Wood, and The Collapse of FTX

If you thought investors were desperate for good news, you were right. A not-as-bad-as-expected CPI report last week set off a buying spree in stocks, the likes of which we haven't seen since the March madness of 2020. Last Thursday's 5.6% rally for the S&P 500, following the release of October inflation figures rising less than expected, was the best rally for that index on a CPI release date in history. It's an obscure record, I know, but typically monthly economic releases of inflation data are pretty mundane events for the markets. But these are not typical times.

In case you missed the details, consumer prices rose just 0.4% last month, less than the 0.7% expected, with inflation coming in at a 7.7% seasonally-adjusted annual rate. That's down from 8.2% in September, and finally headed in the right direction. Investors jumped all over that news, sending the S&P 500 up 5.9% on the week, and the Nasdaq up more than 8%, in the best week for both indexes since last June. The Dow industrials popped more than 4%, and believe it or not, that old index is just 6.7% below its all-time high reached more than a year ago.

According to our pal J.C. Parets of All Star Charts, who's the proud father of two twin baby boys—congrats—one month ago, only one sector—energy—was trading above its 200-day moving average. Today, there are five: energy, financials, health care, industrials, and materials. That's a trend, my friends! October has proven once again that it is not friendly to bear markets. The bulls are trying to make a comeback, and looking for any good news to put money back to work in stocks.

We have to pick apart the collapse of the cryptocurrency trading platform FTX, so I brought in some heavy artillery to do just that. Cryptocurrency platform FTX filed for bankruptcy on Friday, ending a chaotic week in which the company behind FTX denied claims of liquidity problems, was nearly rescued by a buyout from Binance—another big cryptocurrency trading platform—only to have Binance back away from the deal due to—guess what?—liquidity concerns. FTX was hit by a run of withdrawals last week, and the company was facing an $8 billion shortfall. The Wall Street Journal reported that FTX lent billions of dollars to fund risky bets at its affiliated trading firm, Altimeter Research, using money that customers had deposited at FTX for trading purposes.

Meet Lamar Wilson

Lamar Wilson, a.k.a. "Big Marh," is the founder of Black Bitcoin Billionaire, a website focused on providing Bitcoin, cryptocurrency, and generational wealth-building advice. He is also a popular Youtuber.

Throughout his career, Lamar has founded and been involved with numerous business ventures. In 2019, Lamar founded Sunjoined, a hemp cultivation company. Lamar also co-founded Love Will, a financial software technology company specializing in the Blockchain network.

What's in this Episode?

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For crypto watchers and investors, FTX's demise is a wake-up call to the cold facts that there are deep underlying issues in the crypto market that could undermine the investment thesis behind many of these risky coins, and the platforms they trade on. At the heart of the matter is trust, but it's more complicated than that. To help us really understand how FTX fell apart, and what investors should learn from it, is our pal Lamar Wilson, one of the smartest people I know in the crypto world. Welcome back to the Express, "Big Marh."

Lamar: "It's really good to be here, and I'm very sad for a lot of people that have lost a lot of their money and wealth this week, man. It's pretty sad, but I'm happy to be here to try to help educate."

Caleb: "I appreciate that so much. So how could this happen—there was some lending of money, but there was something else going on. From your perspective, how did this whole thing fall apart?"

Lamar: "Well, if you think about it, the issue that I have with all of this, is not just necessarily on FTX, but it's also on those venture capital (VC) firms and the lenders that enabled them. If you think about it, they allowed FTX to use their own Monopoly money, so to speak—their own FTT token—as collateral. Can you imagine that? Could you imagine giving someone a loan against collateral that they created on their own? It seems kind of crazy, right? But that actually creates an environment where you have false valuations of things that then allow you to keep leveraging and leveraging and leveraging, until the whole thing winds up falling apart."

"The crazy part about most of it is that Binance actually owns some of the tokens, and that's what sent this whole thing into a spiral. When one of your major competitors owns a lot of your fake coins that you're using for collateral—when CZ got on Twitter and announced that he was going to sell all of them, that set everything into a spiral and basically pulled the curtain off The Wizard of Oz. And so everyone was able to see what was really going on behind the curtain, and of course, a lot of people—they first mentioned that Binance was going to buy FTX, but I knew that CZ was really just using that as a tactic, to basically just completely put FTX out of its misery. And that's what happened, right? They said they were going to buy it, they looked at the books, and they made another public statement like, "No, we're not after looking deeper.""

"So the way you protect yourself in all of this is—number one—if you're buying Bitcoin, get that Bitcoin off the exchange. Don't allow custodians to hold on to your Bitcoin. Because what we're finding is, even before they looked into FTX, there's a site that basically tracks the balances of all these exchanges, and they were at a negative balance. So that came before all of this fell apart—we were watching this in the Black Bitcoin Billionaires. So when that happens, what you realize is that a lot of these exchanges during the bull market were allowing people to buy Bitcoin that they didn't have—that they didn't have in reserve. And so, once people start doing a bank run, so to speak, or an exchange run to get their Bitcoin, which is a bear instrument, what happens is everything winds up falling apart, because they have to go out into the market to buy Bitcoin, but nobody else even had the Bitcoin to sell."

"So I think this is just the beginning. I think Celsius was the first—not really the first, but one of the bigger "firsts" in this cycle, because this thing happens all the time. But I think we'll see even more of them start to fall apart. I'm hearing about withdrawals not being able to be had in a lot of these different exchanges, and even some of these other OTC desks. And I think that's going to show its ugly head as we continue down this path of unraveling."

"Remember this, though—a lot of these tokens don't have any other value outside of the fact that these people created them. And so, when you're out here looking at DeFi and all these other things, make sure you understand the complexities of how a Ponzi scheme works. Make sure you understand that a lot of this stuff doesn't necessarily have liquidity—it just has value. If somebody makes the token, makes the exchange, they can make it whatever value they want until the cows get called in, right? And when that happens, this is when all heck breaks loose. And that's why we're in the position that we're in right now in this space."

Caleb: "Yeah, well, you answered a lot of my questions in that great explanation. What I really felt this week, last week for the first time, was this impact on price perception, on trust, and on the reality that a lot of investors are facing, that it's really about the "greater fool" theory with a lot of these coins—what's the next person willing to pay for it? And when there's a big run on a lot of these coins, because the perception of value or liquidity changes—and it can change on a dime in these volatile assets, people run for the exits quickly. And when they do, there's really nothing there."

Lamar: "Right. What I really say is, a lot of these things—it's a casino—these exchanges have become casinos. All you have is people making bets, on top of bets, on top of bets, on things that necessarily don't have any intrinsic value. The reason why—and I've been on your channels before—the reason why I always talk about Bitcoin is because it has a certain set of properties. If you go into a casino, the casino makes chips—they're the ones able to print the chips and to distribute those chips."

"With Bitcoin, no one can just create chips—it actually takes work. It takes actual computer hashing power to make sure that you can create new coins. So therefore, the work that is associated with creating and distributing new coins actually adds a layer of value to Bitcoin that all these other coins mostly don't have, because they're built out of thin air. They're basically—you could just create them, it's like making Monopoly money. And then, when you start piling other derivatives on top of the monopoly money—when you start collateralizing on top of the monopoly money, and then everybody realizes this is monopoly money, the rug gets pulled, so to speak, as they say in the crypto space—you get rugged."

"So for me, that's why I really focus on Bitcoin a lot, because I've been in this game for a while. I understand how the technology works, the smart contracts. And most of these smart contracts—most of these coins are built up like Ponzi schemes. And I hope that more people learn from this and this go around. I mean, with some people, it just takes them to feel a little bit of hurt so they can get out of the casino."

Caleb: "Man, a lot of lessons being learned here, and learned very quickly, and you're such a great teacher, Big Marh, we so appreciate you. The Black Bitcoin Billionaires Club—check out Lamar on his YouTube channel, follow him on the social media channels. So good to have you explain this to us. Thanks for being here, my friend."

Lamar: "Thank you very much, Caleb. It's always great to be a part of Investopedia."

Meet Catherine "Cathie" Wood

Catherine "Cathie" Wood is the founder, Chief Executive Officer (CEO), and CIO of ARK Invest, an investment management firm. Cathie has over 40 years of experience in investing and identifying trends in innovation.

Prior to founding ARK in 2014, Cathie spent twelve years at AllianceBernstein as CIO of Global Thematic Strategies, where she managed over $5 billion in capital. Cathie joined Alliance Capital from Tupelo Capital Management, a hedge fund she co-founded, which managed approximately $800 million in global thematic strategies at its peak in 2000. Prior to her tenure at Tupelo Capital, she worked for 18 years with Jennison Associates LLC as Chief Economist, Equity Research Analyst, Portfolio Manager, and Director.

Cathie has been recognized as an influential fund manager across various outlets. In 2018, editors at Bloomberg acknowledged Cathie by selecting her to the magazine's second annual Bloomberg 50 list of influential people across business, entertainment, finance, politics, technology, and science who have defined global business.

Conversation with Cathie

Cathie Wood has had a mercurial past few years. The CEO and Chief Investment Officer (CIO) of ARK Invest couldn't miss with her ARK ETFs, covering innovation, space exploration, genomics, fintech, and robots, among others, in 2020 and 2021. She was front page news, and a highly sought-after guest on business news shows and conferences.

2022 has been less-than-kind to her funds and her fame. Her flagship Ark Innovation ETF (ARKK) is down more than 65% in the past year. Some of her other popular ETFs are down even more. But through it all, Cathie has remained a believer, doubling down on her bets, investing more of her own money in her funds, and defending her firm's thesis and beliefs about how the world is transitioning through digital platforms, Web 3.0, the metaverse, green technology, and innovation writ large.

Full disclosure—I own several of those ETFs in my children's custodial accounts, and it hasn't been fun. Still, Cathie Wood is one of the most dynamic people in the investing world today, and whether you believe in the future that she and her team see or not, you will come away from listening to her a lot smarter, and a lot more curious. I caught up with Cathie at Web Summit in Lisbon a couple of weeks ago, and she was good enough to spend a few minutes with me, for the Express. Here is that conversation:

Caleb: "Cathie Wood, so good to meet you. It's so good to have you, and speak to you here at Web Summit. What's the thing that's most exciting to you about Web 3.0 and decentralized finance (DeFi)? What are you excited about?"

Cathie: "My goodness. The whole DeFi movement is what we believe is a financial services revolution. And so it's going to create incredible opportunities. So we have three full-time crypto analysts right now, studying the three revolutions that we think are going to be caused by Blockchain technology—the money revolution, which is all about the first global, digital, private—no government oversight—rules-based monetary system that the world has ever known. That's a very big idea."

"The second revolution is the financial services revolution that you're talking about, and that is so well represented here, very exciting. And we need these people to make it happen. And then the third is Web3—what many people call Web 3.0, which really is the first global, digital property rights system. And it's really fascinating to watch younger people develop a sense of identity more digitally than they are physically these days. We think the reason that these digital property rights are going to take off is because of that. So we're pretty excited about the whole thing."

Caleb: "It seems outside the U.S., there's a lot more either patience, or anticipation, or optimism, at least when you come to a summit like this. What is it that people are seeing outside the U.S. where people are not seeing inside the U.S., that makes it so attractive and interesting?"

Cathie: "I'm not exactly sure what you mean by the difference, but what we are seeing is a difference between public market investors and private market investors. In the U.S., case in point, Nasdaq down more than a third this year. I think investor time horizons have shortened to one quarter—not even one year. If companies don't make their numbers, then they're sold, which is ridiculous. If you're looking at the future, and we have a five-year investment time horizon to make a decision on one quarter's numbers, is ridiculous. Now, sure, the short terms accumulate to make up the long term, but innovation can be very messy and very volatile in its early stages."

"And I think interestingly, and because of crypto, young people have more tolerance for these long-term opportunities that are going to be very volatile in the short term. They understand, you know, average down into the volatility. If it's downside volatility, upside volatility, take some profits. Psychologically, that's a nice release. If you've taken some profits when something's up 30%, versus if it's down 50%, then it's easy to move back in, because you took those profits."

"So, you know, that's how we manage our portfolio—we trade around the volatility that is inherent to disruptive innovation. And our trading activity adds to our alpha, meaning—we were not to trade our fund around the opportunities in our funds at all, just kept them static. Our trading activity increases the returns. Without that trading activity, our returns would be lower."

Caleb: "And it's also good-old-fashioned dollar-cost averaging, which is good in any environment, whether you're in a bull market or a bear market. Getting into my next question, which is patience and investing. It's actually the magic spice of investing—having patience. But when you are managing quarter to quarter, if you're a public company or a fund manager, investors, and I think the media, don't help. They add to that sort-of impatience and that lack of being willing to wait for things to develop and take their course. How important is it to be patient, and how do you sort-of convince people to hang in there, because we're just in the early stages?"

Cathie: "Well, it's critically important to be patient, especially when it comes to disruptive innovation. Again, it's kind of messy in the beginning, can be very volatile. There's a lot of FUD—fear, uncertainty, and doubt in this kind of investing theme, because the traditional asset management world is so—and this is not private, this is public—is so benchmark-sensitive. We own stocks, for the most part, that are not in the big benchmarks. And many people say, "well, that's a ridiculous way to invest." We beg to differ."

"What we think is the higher-risk way to invest today, given how much innovation is taking place, is to stick with those benchmarks. They will deliver subpar returns, if we're right, and the five major innovation platforms around which we have centered all of our research—genomic sequencing, robotics, energy storage, artificial intelligence, blockchain technology—those technologies are converging, and creating explosive growth opportunities that are going to disrupt the traditional world order. So those people who think they're playing it safe, by sticking close to benchmarks, we think over the next five years are going to find out that that was the wrong bet."

Caleb: "Going into next year, where everybody's pounding the table, saying it's going to be a recession, or maybe it won't be—does it matter, and how much, to the technologies you're investing in, or does it maybe create a little bit of space for those to develop it a little bit more?"

Cathie: "Yes. So we believe we're in a recession, have been since the beginning of the year, and now most people are saying it will be next year. So we think that the recession will continue. But it's primarily an inventory recession, that during the supply shock that we saw, we also saw companies double-ordering, triple-ordering, more than they needed if the supply chain got back into balance. Here we are, and so we do think we're going to have an inventory recession.

But this is not like '08, '09 at all, in terms of how innovation stocks behave. Well, during a recession, ARK companies tend to grow through the recession. And the other thing that happens during a recession, and the headwind we've been fighting the last year-and-a-half, is interest rates tend to come down, inflation comes down, and we think all of those things are in the process of happening. So 2023 should be a great year for innovation investing."

"I mean, we were hit the hardest starting in February of 2021, not even the beginning of this year—it was almost a year before that, that our underperformance started, solely because inflation and interest rates were ticking up. If we're on the other side of that, then the algorithms that have taken our portfolios down 70%, 80%—they're going to have to change their minds. You know, they really are very simplistic in their way of looking at the world. They see interest rates going up, they banish innovation. They see interest rates coming down—they'll welcome it again."

Caleb: "Who is your greatest influence as an investor—who really helped get you into the game, and who have you really learned from? Who was that person that sort-of got you on your way?"

Cathie: "My first Chief Investment Officer was Sig Segalas at Jennison Associates. I was there for 18 years, grew up there, and he knew Mr. Hewlett, and Mr. Packard, and Gordon Moore, and all of the greats of all times. And so, he inspired me with his love of technology that my father had also inspired me with. But I got a way to fulfill it in the financial markets, and, just this idea that innovation solves problems, that it creates incredible growth opportunities for not only investors, but people who get on the right side of change."

"That's why ARK takes so seriously our role in terms of educating the public. Innovation is the great leveler. My father—sixth grade education, Irish Army, American Air Force, dawn of the electronic age—he learned about radar systems and made his way through this world, was able to provide for his family. I watched that growing up, and I see with all the innovation there is out there now, even the best-schooled people in the world—they don't know that much about 3D printing, or drones, or artificial intelligence. Those who get in on the ground floor and just learn and follow—on Twitter—follow our analysts on Twitter, and follow who they follow—they can become better educated on some of these new technologies than people who are in the finest schools in the world today."

Caleb: "The information is coming from everywhere. Social media has been a good place for that in a lot of ways. For all of its ills, social media does help us get access to that information. How do we get more women into investing, and especially into investing sort-of at the forefront like you are? How do we drive that?"

Cathie: "Well, you know, I actually was talking to the CEO of PagerDuty—a woman, today about this, because we are finding it difficult to attract women even to ARK, even though it's a woman-led company. And what she said to me was helping her, and I'm going to try this. If you say you want quality of life, you want work-life balance, come to our company. We respect, not just women, but mens' need for a balanced life."

"Now, if you're passionate about artificial intelligence or blockchain technology, you'll probably spend more than six-to-eight hours a day just because you want to. Those are the kinds of people that we attract. But if you don't want to, we're a great place to work. We're looking for five analysts right now—I can be advertising this with you. We're looking for five research associates, either fresh out of school or just a couple of years of work experience, who have domain expertise in one of our technologies. And you can see how our analysts' responsibilities are broken out by technologies on our website, ARK-invest.com."

Caleb: "Finally, let's go out on this. What's your favorite investing term of all time? Investopedia is built on its terms. A lot of people know us for the dictionary. What's that investing term or finance term that just gets you going, that you love?"

Cathie: "Well, what I don't think people understand enough, and this is it's somewhat what you're talking about—many people do not understand what the words "exponential growth" mean. There's linear growth—most of us grew up in a linear growth world. You know, where you would have growth very strong in the beginning, but then it decays, and you get this idea of "reversion to the mean" or "reversion to GDP growth." ARK is looking for exponential growth opportunities, and there are so many of them. What that means—and this happened to Amazon—so the Internet was our first glimpse of what exponential growth could mean."

"In 2002, when we were trying—I was trying to sell the firm—I was out at the time on Amazon. Amazon had only a $5 billion market cap back then. I was saying, why don't you put 25% revenue growth for the next 25 years, or 20 years, into your dividend discount models, and tell me what you spit out? And it's a buy all day long if you really believe you can sustain growth at that level. We believe that with our technologies, we're going to have so many exponential growth trajectories, and we also believe that most people are not expecting this, because we've grown up in a linear world. So it's going to be exciting."

"Many people in the traditional world, because of what happened during the tech and telecom bubble and then the bust—many people in the traditional world are scared of this notion of exponential growth. The muscle memory is very bad, right? They did not have a good experience, if they if they were in the market at that time. And that's what's making this opportunity so interesting. Back then, investors were just flocking to it. The technologies weren't ready yet. We didn't get plowed until 2006. We didn't get deep learning until 2012. We didn't get costs low enough in DNA sequencing until a few years ago. So the timing was not right back then, but it is now. And what's happening? Investors are running away—they're running for the hills. Where are the hills? Their benchmarks. And that's going to be a mistake."

Caleb: "We love that term, exponential growth, and the cousin of that—risk/reward, because you have to be able to take that risk and believe in it to get the reward, on the flip side. Cathie Wood from ARK Invest, so good to talk to you. Thanks for spending some time with us."

Cathie: "Thank you, Caleb. I love the service that you're doing for the future generations. I love it. And for the current generations, you know, this is really important."

Term of the Week: Cold Wallet

It's terminology time. Time for us to get smart with the investing term we need to know, this week. And this week, it's a reader's pick, in that there was so much traffic to Investopedia.com last Thursday and Friday, as FTX imploded, that I decided to select the investing term with the most traffic, and explain it here, on the Investopedia Express. That term: "cold wallet." You heard Big Mahr refer to it earlier, when we were talking about FTX. Well, what is it cold wallet? A cold wallet is used offline for storing Bitcoins and other cryptocurrencies. With a cold wallet, also originally known as cold storage, the digital wallet is stored on a platform not connected to the internet, thereby protecting it from unauthorized access, cyber hacks, and other vulnerabilities that a system connected to the Internet is susceptible to.

If you have a cold wallet, or keep your crypto in cold storage, a cryptocurrency transaction to receive new tokens might look a little like this: First, you connect the hardware to an Internet-enabled computer. Then, you select the option to receive tokens—the device generates an address to facilitate the transaction. The sender initiates a transfer of tokens to the address generated, and then the investor disconnects the hardware wallet, which contains the public and private keys, and the information remains offline. A cold wallet is different in that way from a "hot wallet," which is where a lot of crypto investors keep their coins on platforms like Coinbase and FTX, among others. If you're thinking about investing in crypto, make sure you know how these systems work. We're going to be dropping some helpful links into the show notes below.