Why FTX account holders are unlikely to get their money back

Why FTX account holders are unlikely to get their money back

RRoughly two weeks after bankrupt cryptocurrency exchange FTX filed for bankruptcy, its clients are losing hope they will ever see their money again.

The latest blow to FTX account holders came Tuesday in a U.S. federal bankruptcy hearing when FTX lawyers painted a bleak picture of the Bahamian firm’s finances and revealed that a “significant amount of assets” from users’ accounts had either been stolen or went missing. They said FTX faced cyberattacks the day it filed for bankruptcy, referring to hundreds of millions of dollars worth of FTX assets that were moved in unauthorized transactions.

FTX’s hack claim reduces 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 can wait years to get their lost funds back, and it’s entirely possible that they won’t 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 unsecured creditors like everyone else in bankruptcy where there is apparently an $8 billion deficit. It’s a strange situation.”

Court documents filed earlier this month show the firm owes $102 million to customers and at least $3.1 billion to about 1 million creditors.

Once a darling of the crypto world, FTX filed for bankruptcy in early November after a run on deposits caused a liquidity crunch. The collapse of the firm prompted an investigation by the Securities and Exchange Commission and the US Department of Justice, as well as authorities in the Bahamas. The investigation mainly focuses on whether FTX wrongfully transferred client assets to Alameda Research, a cryptocurrency hedge fund owned and operated by FTX founder Sam Bankman-Freed, who stepped down as CEO while filing for bankruptcy. Wall Street Magazine reported that Bankman-Fried allegedly used $10 billion in FTX client assets to fund risky bets at Alameda Research.

“This company was run by inexperienced, inexperienced and potentially compromised people,” FTX’s own lawyer, James Bromley, said at a Nov. 22 bankruptcy hearing. “This is one of the most dramatic and complex corporate failures in the history of corporate America. “.

The cryptocurrency industry has faced a painful reckoning this year after rising in popularity during the pandemic. The value of crypto assets was falling even before the FTX crash, which Ibrahim says is a sign of a “bad offshore bank” rather than an industry failure. For example, the value of one bitcoin has plummeted from about $68,000 a year ago to $17,000 today.

But clients who have placed their trust in the FTX platform are likely to be at the end of the line for any assets that a bankruptcy judge may extract from the company. As a firm goes through bankruptcy proceedings, U.S. law allows the court to change priorities based on principles of equity, meaning that creditors are likely to have priority first, while investors in the company will be second, and owners accounts – last.

Alan Rosenberg, a Florida-based corporate bankruptcy attorney, says it’s “too early to tell” whether clients will recover their funds, although a series of legal decisions in the coming months or years should make the outcome clearer. He says the first question the courts will have to answer is what property the bankruptcy estate owns and whether FTX has “clear legal ownership” of the cryptocurrency traded on its platform, which would determine whether FTX has any or share in these assets. The courts will also have to decide on the different classes of creditors, which may include clients if the judge determines they are unsecured creditors.

“What’s worse is that Sam Bankman-Fried seems to suggest that the firm’s financial statements are generally unreliable,” says Rosenberg. “This means that it may not be possible to determine whose cryptography was used, whose cryptography was not used, and what is left.”

Rosenberg adds that a number of other legal issues could drag out the case for years, including a termination lawsuit, a fraudulent transfer lawsuit, a preference lawsuit, and an insurance lawsuit. “It looks like there are assets,” he says, “but the question is who claims them, what is the priority of these claims, and what additional assets can be sued?”

Read more: The collapse of FTX will have a lasting impact on the African crypto community

The collapse of FTX also drew attention to the unregulated world of cryptocurrencies, an industry that deliberately operates outside of traditional banking and financial regulations. When a traditional American bank fails, the government insures customer deposits, boosting them up to $250,000 through the Federal Deposit Insurance Corporation (FDIC). But at the moment there is no such mechanism for cryptocurrencies.

“We have a growing asset class that is largely unregulated globally,” says Eric Sufer, a partner at Tusk Strategies, where he leads the Crypto and FinTech practice group. “The collapse of FTX is prompting calls for regulators to finally step into the game. We’ve had enough of turf wars in Washington and finger-pointing between the ultimate agency soup over who can do what and when.”

An effective set of rules will likely give investors more confidence when investing in the currency, crypto experts say, although politicians in Washington are still trying to make sense of the FTX explosion. Sen. Debbie Stabenow, a Michigan Democrat, said the collapse of FTX “reinforces the urgent need for increased federal oversight of the industry” and continues to push the measure through Congress.

Ibrahim, professor of securities law, urged regulators to require that any digital asset be accompanied by both a technical document explaining how the native blockchain works, and a “warning box” that exposes that asset’s potentially dangerous features, a protection that would alert customers . that FTX lends funds to Alameda’s clients.

Of course, any changes in cryptocurrency regulation in the coming months will not help FTX customers recover their funds. The lack of good news is prompting some account holders to sign a class action lawsuit filed last week against Bankman-Fried and FTX-supporting celebrities such as Tom Brady and Stephen Curry as another chance to recoup lost money.

“If I try to sue Tom Brady for my losses on FTX, I can tell that he is an insurer offering securities,” says Ibrahim. “He will be held responsible for this under the securities laws.”

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