Customers who trusted the crypto giant FTX may be left with nothing

New York
CNN business

As the dust settles from one of the most shocking financial implosions in history, one of the main unknowns is how much customers who can’t access their money can expect to get back from FTX, the crypto exchange that failed last week.

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

Before it went public, 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 used client funds to back its sister hedge fund’s high-risk trading operation without authorization.

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

Federal prosecutors in New York are now investigating the collapse of the exchange, a person familiar with the matter told CNN. And authorities in the Bahamas, where FTX is based, launched a criminal investigation over the weekend.

The legal ramifications for FTX and its founder, Sam Bankman-Fried, are unclear. But as the exchange, once valued at more than $30 billion, collapses, it’s increasingly likely that customers who gave their money to FTX will be left holding the bag.

“We don’t know the extent of the contamination,” said Howard Fischer, a partner at the law firm Moses Singer and a former attorney at the Securities and Exchange Commission. “The first ring of victims are people who had assets in FTX… They probably won’t be made up, or at all.”

There are a few reasons for this.

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

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, at least, it is not clear how much will be left to pay.

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

In bankruptcies, Snyder explained, there is a fairly simple formula for determining how much creditors—in this case, FTX deposits—will receive.

“The numerator is active, the denominator is passive. You divide one into the other, and [result] it’s what everybody gets,” he said. “But if people get all the assets out, then there’s not going to be a big counter.”

He added: “It is highly conceivable that the return will be minimal at best.”

Of course, the suddenness of FTX’s collapse makes it a difficult case to assess at the outset, lawyers say.

Typically, companies would have weeks to prepare their bankruptcy filings, including explaining whether the company sought Chapter 11 protection and what it wants to achieve in bankruptcy court.

Dan Besikof, a partner at Logan & Loeb LLP who specializes in bankruptcy, says it’s too early to say whether clients will get their money back.

“All you can do is guess where things are from the tweets,” he said. “And how customers get their money back can depend on a number of things, including which entity they hold the money with, how much of which currency they have left.”

The collapse of FTX 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, CEO of rival Binance FTX, sought to reassure his audience about the legitimacy of the sector.

“People are obviously nervous,” Zhao, known as CZ, said during the question-and-answer session. on Twitter. “I mean, in the short term, it’s painful. But I think that’s really good for the industry in the long run.”

The crypto exchange giant emerged as a rescue for FTX last week, before canceling its offering.

Zhao, whose tweet announcing Binance’s divestment from FTX helped fuel the small firm’s liquidity crisis, has denied having a “master plan” to expose FTX. However, critics say the biggest, and perhaps only, winner of FTX’s fall is none other than Zhao, today arguably the richest and most influential player in digital asset trading.

“Because some people blame me for blowing the whistle or blowing a bubble, I apologize for that… I apologize for the confusion I’ve caused. But I think at any time, if there’s a problem, the sooner it’s revealed, the better.”

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