The latest blow to FTX account holders came in a bankruptcy hearing in US federal court on Tuesday, when FTX’s lawyers painted a bleak picture of the Bahamas-based company’s finances and revealed that a ” substantial amount of activity” from user accounts has either been stolen or missing. They said FTX suffered cyberattacks the day it filed for bankruptcy, referring to the hundreds of millions of dollars in FTX assets that were moved in unauthorized transactions.
FTX’s claim that it has been hacked decreases the likelihood of users getting their money back, legal and banking experts say. Without a clear understanding of how much money FTX has left and where it is, customers could wait years to recover lost funds and it is possible that none will be returned.
“I highly doubt users will get their money back,” says Darian Ibrahim, a professor at William & Mary Law School who specializes in securities law and cryptocurrencies. “They are as unsecured creditors as anyone else in a bankruptcy where there is apparently an $8 billion deficit. It’s a bizarre situation.”
Court documents filed earlier this month show the company owes $102 million to customers and at least $3.1 billion to about 1 million creditors.
Once the darling of the cryptocurrency world, FTX filed for bankruptcy in early November after a run on deposits caused a liquidity crunch. The company’s collapse sparked investigations by the Securities and Exchange Commission and the Department of Justice in the United States and by authorities in the Bahamas. The investigation largely focuses on whether FTX improperly transferred client assets to Alameda Research, a cryptocurrency hedge fund owned and operated by FTX founder Sam Bankman-Fried, who stepped down as CEO at the time of the bankruptcy declaration. The Wall Street Journal reported that Bankman-Fried allegedly used $10 billion of FTX client assets to fund risky bets at Alameda Research.
“This company was run by people who were inexperienced, unsophisticated and potentially personally compromised,” FTX attorney James Bromley said in a November 22 bankruptcy hearing. .”
The cryptocurrency industry has faced a painful reckoning this year after witnessing a surge in popularity during the pandemic. Cryptocurrency values were declining, even before the collapse of FTX which Ibrahim says is endemic to a “bad offshore bank” rather than an industry failure. The value of a single Bitcoin, for example, has dropped precipitously, from about $68,000 a year ago to $17,000 now.
But customers who have trusted FTX’s platform are likely at the back of the queue to receive whatever assets a bankruptcy judge can extract from the company. As the company enters bankruptcy proceedings, US law allows the court to rearrange priorities based on fair principles, meaning that creditors are likely to have first priority while investors in the company are second and account holders are last. .
Alan Rosenberg, a corporate bankruptcy attorney in Florida, says it’s “too early to tell” whether clients will get their funds back, though a series of legal decisions over the next few months or years should make the outcome clearer. He says the first question the courts will need to answer is what ownership the bankruptcy estate owns and whether FTX has “bare legal title” to the cryptocurrency traded on its platform, which would establish whether FTX has equity in those assets. Courts will also have to decide the different classes of creditors, which could include customers if a judge determines that they are unsecured creditors.
“What makes matters worse is that Sam Bankman-Fried seems to be suggesting that the company’s financial records aren’t reliable at all,” Rosenberg says. “This means that it may be impossible to determine which cryptocurrency has been used, which cryptocurrency has not been used, and what is left.”
A litany of other legal issues could drag out the case for years, including avoidance litigation, fraudulent transfer litigation, preference litigation and insurance litigation, Rosenberg adds. “There appear to be assets,” he says, “but the question is: who claims them, what is the priority of those claims, and what additional assets can be brought to bear?”
Read more: The FTX crash will have a lasting impact on the African crypto community
The FTX implosion also shone a spotlight on the unregulated world of cryptocurrencies, a sector that has intentionally operated outside traditional banking and finance rules. When a traditional US bank fails, the government insures customer deposits, making them whole up to $250,000 through the Federal Deposit Insurance Corporation (FDIC). But, for now, there is no such mechanism for cryptocurrencies.
“We have a growing asset class that is largely unregulated globally,” says Eric Soufer, a partner at Tusk Strategies, where he leads the firm’s Crypto and FinTech practice group. “FTX’s collapse raises calls for regulators to finally step in. We’ve had enough of the turf wars in Washington and the finger pointing among the latest agency soup about who gets to do what when.
An effective set of regulations would likely give investors more confidence to invest in the currency, crypto experts say, though Washington policymakers are still struggling to make sense of the FTX implosion. Senator Debbie Stabenow, a Democrat from Michigan, said the collapse of FTX “reinforces the urgent need for increased federal oversight of this industry” and continues to push a measure through Congress.
Ibrahim, the securities law professor, has called on regulators to require any digital asset to come with both a white paper explaining how native blockchain works and a “warning box” revealing potentially harmful characteristics of that asset, a hedge that would have warned clients about FTX lending client funds to Alameda.
Of course, any moves on cryptocurrency regulation in the coming months will not help recover FTX client funds. Lack of good news is prompting some account holders to sign a class action lawsuit filed last week against Bankman-Fried and celebrities who have endorsed FTX, such as Tom Brady and Stephen Curry, as another chance to get their money back lost.
“If I’m trying to sue Tom Brady for my FTX losses, I could say he’s an underwriter and an offering of securities,” Ibrahim says. “He would be liable under securities laws for that.”
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