Customers who trusted crypto giant FTX can be left with nothing

New York
CNN affairs

As the dust settles on one of the most shocking financial implosions in history, one of the main unknowns is how many customers who cannot access their funds expect to get back from FTX, the crypto exchange that went bankrupt last week.

The answer, according to legal experts, may be zero.

Before it fell apart, marketed itself as a safe destination for beginners to buy and sell cryptocurrencies. But a liquidity crunch last week forced FTX to halt withdrawals, leaving customers and investors in limbo. According to the Wall Street Journal, FTX allegedly used client money to support its sister hedge fund’s high-risk trading activities without authorization.

On Friday, FTX and the hedge fund Alameda Research filed for bankruptcy.

Federal prosecutors in New York are now investigating the stock market’s collapse, a person familiar with the case told CNN. And authorities in the Bahamas, where FTX is based, launched a criminal investigation into the company this weekend.

The legal ramifications for FTX and its founder, Sam Bankman-Fried, remain unclear. But as the exchange, once valued at more than $30 billion, collapses, it seems increasingly likely that customers who handed over their money to FTX will be able to hold onto the bag.

“We just don’t know how big the contagion is,” said Howard Fischer, a partner at law firm Moses Singer and a former attorney for the Securities and Exchange Commission. “The first ring of victims are the people who had assets in FTX…They probably won’t be recovered, or come anywhere near that.”

There are a number of reasons for this.

In a traditional US bank failure, the government insures customer deposits up to $250,000. But there is simply no mechanism for deposit guarantee schemes in the largely unregulated world of cryptocurrencies.

In theory, FTX’s clients should get a portion of what’s left of the company’s assets at the end of the bankruptcy process. But so far it is in any case not clear how much is left to pay out.

“As far as I know, they have two assets: the goodwill value of the exchange and the value of their FTT coins,” said Eric Snyder, chief of the bankruptcy division of the Wilk Auslander law firm. (Goodwill value refers to intangible assets such as a brand’s reputation and intellectual property. And FTT coins, the crypto token issued by FTX, have lost more than 90% of their value in the past week.)

In bankruptcies, Snyder explains, there’s a fairly simple formula for figuring out how much creditors — in this case FTX depositors — will receive.

“The numerator is the capital, the liability of the denominator. You divide one into the other, and the [result] is what everybody gets,” he said. “But if people pull out all the assets, there won’t be much of a counter.”

He added: “It is quite conceivable that returns will be minimal at best.”

Of course, FTX’s sudden demise makes it a difficult case to judge at an early stage, lawyers say.

Typically, companies would have weeks to prepare bankruptcy filings that explain, among other things, why the company sought Chapter 11 protection and what it aims to accomplish in bankruptcy court.

Dan Besikof, a partner at Loeb & Loeb who specializes in bankruptcies, says it’s too early to tell if customers will get refunds.

“All you can really do is guess from tweets where things stand,” he said. “And how customers get their money back can depend on many different things, including which entity they hold the money through, what amount of coins are left.”

The FTX outage has thrown the entire crypto industry into turmoil, raising serious questions about the future of digital assets and the lack of global regulation.

On Monday, Changpeng Zhao, the CEO of FTX competitor Binance, tried to reassure his audience about the industry’s legitimacy.

“Obviously people are nervous,” Zhao, commonly known as CZ, said in a question-and-answer session on Twitter. “I want to say, in the short term, it is painful. But I think this is actually good for the industry in the long run.”

The giant crypto exchange briefly emerged as a lifeline for FTX before changing course last week.

Zhao, whose tweet announcing Binance’s divestment of FTX fueled the smaller company’s liquidity crisis, has denied having a “master plan” to expose FTX. Still, critics note that the biggest, and perhaps only, winner in FTX’s demise is none other than Zhao, now unquestionably the richest and most influential player in digital asset trading.

“As much as some people blame me for whistleblowing or bursting the bubble, I apologize for that… I apologize for any disturbance I have caused. But I think if there is a problem, the sooner we reveal it the better.”

— Matt Egan and Kara Scannell of CNN Business contributed to this article.

Correction: An earlier version of this article misrepresented the name of the law firm Loeb & Loeb.

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