Coming at a time of tightening credit markets, cryptocurrency business bankruptcies are making big headlines for their sudden entries into bankruptcy courts following rapid declines in the value of digital assets. From July 2022 to January 2023, there have been several bankruptcies filed by crypto brokerages, exchanges, and lenders, resulting in a significant evaporation of value. All signs suggest that more crypto bankruptcies are coming, so investors should understand the potential impact of digital assets held or invested in an exchange.
What Is Causing the Crypto Bankruptcies?
The reasons for these bankruptcies vary, including alleged fraud in the case of FTX Trading Ltd. However, the start of a broader crypto sell-off in the market began in May 2022 with the collapse of the Terra Luna coin and the related “stablecoin” TerraUSD. Within a few days, Terra Luna and TerraUSD both lost substantial value, leading many crypto investors to begin seeking to withdraw their digital assets from various crypto exchanges and brokerages. This led to the failure of crypto hedge fund Three Arrows Capital (or 3AC), which had significant exposure to Terra Luna. Numerous future Chapter 11 filers had loaned money to 3AC, including BlockFi (a cryptocurrency lender), Celsius Network (a cryptocurrency lender), and Voyager Digital (a cryptocurrency brokerage). In particular, Voyager Digital loaned $665 million to 3AC; and when 3AC defaulted on the loan, Voyager filed for Chapter 11. In May 2022, investors withdrew over $1 billion from the Celsius Network platform due to what the CEO of Celsius referred to as a generalized “distrust of cryptocurrency.” Over the course of 2022, the value of Bitcoin dropped approximately 65 percent.
What has followed is a wave of digital asset freezes, followed shortly thereafter by a wave of Chapter 11 bankruptcies in the United States. Celsius Network froze its platform for trading digital assets on June 12, 2022, and then filed for Chapter 11 on July 13, 2022. Voyager Digital froze its trading on July 1, 2022, and then filed for Chapter 11 on July 5, 2022. FTX Trading Ltd. (a cryptocurrency exchange and hedge fund) froze its platform for trading on November 8, 2022, and then filed for Chapter 11 on November 11, 2022. The FTX trading freeze had a serious impact on BlockFi, which had $355 million of assets at FTX. BlockFi also made loans to Alameda Research, an FTX affiliate and hedge fund, which defaulted on approximately $680 million in collateralized loan obligations. BlockFi limited customer withdrawals on November 10, 2022, and then filed for Chapter 11 on November 28, 2022. Genesis Global Capital (a cryptocurrency lender) froze customer redemptions on November 16, 2022, and then filed for Chapter 11 on January 20, 2023. Similar to other crypto bankruptcy filers, Genesis loaned significant amounts to 3AC and Alameda Research, both of which filed insolvency proceedings in 2022.
Most of these Chapter 11 filings occurred with little preplanning, which is rare in contemporary large Chapter 11 filings. Customarily, large companies will conduct weeks or months of planning and negotiations with its creditors prior to filing for bankruptcy, which typically helps to shorten the bankruptcy process and ensure greater certainty as to results. Instead, each of these crypto businesses has largely free-fallen into bankruptcy court, without a go-forward plan, following a rapid decline in value.
The FTX Collapse
The FTX bankruptcy caused significant disruption in the broader market for cryptocurrencies due to its size and perceived stability before its collapse. Sam Bankman-Fried, the majority owner of FTX and its affiliates, was arrested on December 12, 2022, for various alleged crimes connected to his operation of FTX, including wire fraud, securities fraud, and money laundering. Among the allegations by prosecutors is that Bankman-Fried diverted billions of dollars of customer funds for his personal use and to make investments. Bankman-Fried pleaded not guilty to the charges. On December 21, 2022, Caroline Ellison, the CEO of Alameda Research, and Gary Wang, FTX’s cofounder and chief technology officer, each pleaded guilty to charges that they helped Bankman-Fried in a years-long scheme to defraud investors.
At 4:30 a.m. on November 11, 2022 (the day that FTX filed for bankruptcy), Bankman-Fried resigned his CEO role, and all corporate powers and authority were delegated to John J. Ray III, including the power to appoint independent directors and commence the Chapter 11 cases. Ray appointed five restructuring experts as independent directors of each of the five business silos that FTX operated prebankruptcy. Ray has significant restructuring experience, having worked as a chief restructuring officer or CEO on other large corporate failures, such as Enron and Residential Capital.
In the first-day affidavit filed by FTX with the bankruptcy court, Ray stated that he has never seen such a failure of corporate controls and such a complete absence of trustworthy financial information. Ray indicated that he has no confidence in the financial statements produced while Bankman-Fried was in control of FTX, that FTX did not have an accounting department, and that FTX did not have a centralized cash-management system throughout its corporate structure. Under its former leadership, FTX did not keep appropriate books and records, or even security controls, for its digital assets, and Bankman-Fried and Wang controlled nearly all access to digital assets in FTX. Ray has engaged forensic analysts to assist in identifying FTX assets on the blockchain, and cybersecurity professionals to identify any unauthorized transactions.
As a sign of just how volatile these crypto bankruptcies can be, FTX filed for bankruptcy a mere twenty-three days after it sought and received bankruptcy court approval to purchase the digital assets of Voyager Digital for $1.4 billion. That sale fell through and, as of December 19, 2022, BAM Trading Services Inc. (known as Binance.US) was selected as the winning bidder for Voyager Digital’s assets. The deal with Binance.US is valued at $1 billion, and Voyager estimates that the sale will allow its customers to recover approximately 51 percent of the value of their digital asset deposits at the time Voyager filed for bankruptcy.