The recent and dramatic collapse of FTX, the Bahamas-based cryptocurrency exchange launched in 2019 by Sam Bankman-Fried, is likely to result in years of litigation in numerous jurisdictions, according to Dan Wyatt, Partner at RPC, an international commercial law firm headquartered in London.
After receiving backing from some of the biggest names in venture capital, and ultimately becoming one of the world’s largest crypto exchanges by volume, FTX filed for bankruptcy on November 11th, 2022, in the US court system following a liquidity crisis.
The trouble started a week ago when a popular crypto industry news service reported that a crypto hedge fund also owned by Bankman-Fried held billions of dollars worth of FTT, which is FTX’s own cryptocurrency, and had been leveraging it as collateral in risky trades.
A Reuters report claims that as much as $10 billion in user funds were moved to sister firm Alameda Research, with sources revealing that $1 billion to $2 billion in client money is unaccounted for.
Touted to be the world’s first trillionaire, Bankman-Fried’s net worth reportedly fell from more than $16 billion to roughly $3 dollars overnight.
On Sunday, things escalated when Changpeng Zhao, the Chief Executive Officer (CEO) of cryptocurrency exchange Binance – which together with FTX processes the majority of crypto trades around the world – announced on social media that his firm was selling its roughly $500 million FTT holdings, citing recent revelations.
In response, FTX customers began attempting to withdraw funds at a rapid pace. According to a Reuters report, FTX’s founder said that users tried to withdraw $6 billion in crypto tokens over three days, whereas daily withdrawals typically ran to tens of millions of dollars.
Zhao later announced plans to acquire FTX, but announced a day later that following due diligence he was stepping back from the deal.
According to mainstream media reports, bankruptcy filings reveal that more than one million people and businesses could be owed money as a result of the collapse of FTX, with the crypto exchange reportedly needing to find some $4 billion to remain solvent, with a funding gap as high as $8 billion.
Clearly, it’s a messy situation and it seems that users stand to lose a lot of money unless FTX can find the billions of dollars needed to meet the withdrawal demands, or at the least reassure clients that their money is both there and safe.
Of course, it’s not just large, wealthy businesses and investors, but also ordinary people that will have funds (some likely a significant amount) tied up in FTX.
“Whatever the reasons for FTX’s collapse, its customers are likely to lose out significantly,” said Wyatt, a specialist in complex financial services litigation including crypto/digital assets. “If fraud or irregular accounting issues are identified then we expect they will look to bring actions against those directly involved in the events leading to FTX’s downfall but also wider third parties such as banks, professional advisers and others who played a part.”
“In all major financial scandals, from Enron to Madoff to Wirecard, claimants have looked to pursue those businesses that have deep pockets.
“The biggest UK and international banks have shown caution in their dealings with crypto institutions and funds deriving from them, mainly out of concerns over money laundering but no doubt also with one eye on possible litigation arising from a situation like the one currently unfolding at FTX,” he continued.
As noted by Wyatt, the lack of segregated client accounts is a big problem for most crypto exchanges, heightening the risk of mismanagement leading to a liquidity crisis of the likes experienced by FTX.
“But most importantly, unsegregated client accounts mean that, in an insolvency, investors will be unsecured creditors and so will get back only a few pence in the pound. They will have to turn to litigation, likely against third parties with deep pockets, to seek to recoup some of their losses – we will therefore see a raft of claims in multiple jurisdictions relating to the downfall of FTX for many years to come,” said Wyatt.
It will be interesting to see where this goes, and if the impressive rise and likely more impressive downfall of one of the world’s leading crypto exchanges results in much needed regulation for the market.
