As the dust settles from one of the most shocking financial meltdowns in history, one of the major unknowns is how much customers without access to their funds can expect a return from FTX, the cryptocurrency exchange that filed for bankruptcy last week.
The answer, according to legal experts, may be zero.
Prior to its breakup, FTX.com marketed itself as a safe destination for beginners to buy and sell cryptocurrency. But a liquidity crunch last week forced FTX to halt withdrawals, leaving clients and investors in limbo. FTX reportedly used client funds to support the high-risk trading operation of its sister hedge fund without permission, according to the Wall Street Journal.
On Friday, FTX and its hedge fund, Alameda Research, filed for bankruptcy.
A person familiar with the matter told CNN that federal prosecutors in New York are now investigating the stock market crash. Authorities in the Bahamas, where FTX is headquartered, launched a criminal investigation into the company over the weekend.
The legal ramifications for FTX and its founder, Sam Bankman-Fried, remain unclear. But with the stock market, once worth more than $30 billion, crashing, it seems increasingly likely that customers who handed their money over to FTX could be left with the bag.
“We don’t know how widespread the contagion is,” said Howard Fisher, a partner in law firm Moses Singer and a former attorney with the Securities and Exchange Commission. “The first cycle of victims are the people who have assets held in FTX… they probably won’t become full or anywhere close to it.”
There are several reasons for this.
In the event of a failure of a traditional American bank, the government insures customer deposits, bringing them in full up to $250,000. But there is simply no mechanism to secure depositors in the highly unregulated world of cryptocurrencies.
In theory, FTX clients should receive a portion of what is left of the company’s assets at the end of the bankruptcy process. But so far, at least, it is not clear how much will be disbursed.
“As far as I know, they have two assets — the reputational value of the exchange and the value of their FTT coins,” said Eric Snyder, head of bankruptcy at law firm Wilke Auslander. (Goodwill refers to intangible assets such as brand reputation and intellectual property. FTT Coins, the crypto token issued by FTX, has lost more than 90% of its value over the past week.)
Snyder explains that in bankruptcies, there’s a fairly simple formula for figuring out how much creditors — in this case, FTX depositors — will get.
“The numerator is the origins, the liability of the denominator. You divide one into the other, and [result] is what everyone gets.” “But if people took out all the assets, there wouldn’t be much of a numerator.”
“It is very plausible that the return will be minimal at best,” he added.
Of course, the suddenness of FTX’s fall makes it difficult to assess this early on, lawyers say.
Typically, companies have weeks to prepare bankruptcy filings that reveal, among other things, an explanation of why the company is seeking Chapter 11 protection and what it aims to achieve in bankruptcy court.
Dan Pechikov, a partner at Loeb & Loeb who specializes in bankruptcy, says it’s too early to say whether clients will get any money back.
“All you can really do is guess from the tweets where things stand,” he said. “And how customers get their money back may depend on a lot of different things, including which entity they are holding the money through, and how much coins they still have left.”
The FTX fallout has shaken the entire crypto industry, raising serious questions about the future of digital assets and the lack of global regulation.
On Monday, Changpeng Zhao, CEO of FTX rival Binance, sought to reassure his audience about the sector’s legitimacy.
People are obviously nervous,” Zhao, widely known as CZ, said in a question-and-answer session. on Twitter. “I want to say, in the short term, it hurts. But I think in the long term it’s really good for the industry.”
The giant cryptocurrency exchange briefly emerged as a lifeline for FTX before reversing course last week.
Zhao, whose tweet announcing Binance’s divestiture in FTX helped fuel the smaller company’s liquidity crunch, denied there was a “master plan” to expose FTX. However, critics note that the biggest, and perhaps only, winner in FTX’s downfall is none other than Zhao, who is now undoubtedly the richest and most influential player in digital asset trading.
“As much as some people blame me for whistleblowing or puncturing the bubble, I apologize for that… I apologize for any upset I caused. But I believe that at any time, if there is a problem, the earlier we reveal it, the better.”
CNN Business’ Matt Egan and Kara Scannell contributed to this article.
Correction: An earlier version of this article misstated the name of the law firm Loeb & Loeb.
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