The fall of FTX

Answer

FTX had a dizzying rise and an even more dramatic fall. FTX had raised $1.8 billion since its launch in 2019, and its most recent valuation prior to its staggering collapse, where its value evaporated, was $32 billion. The $16 billion personal fortune of Sam Bankman-Fried (known as ‘SBF’) was also vaporised.

The stunning fall of SBF’s crypto empire has amounted to a global investigation. More than 100 affiliated companies filed for Chapter 11 bankruptcy in Delaware. The companies face at least 100,000 creditors but this number will likely increase to one million with the majority of creditors being clients of SBF’s companies. There’s significant global regulatory interest; FTX said in its court filings that it has been in contact with dozens of federal, state and international regulatory agencies, the Commodity Futures Trading Commission, and the Securities and Exchange Commission. Financial regulators in the Bahamas also appointed liquidators to run a key FTX entity, FTX Digital Markets.

FTX’s fall is in no doubt the most impressive collapse, but the wider industry has been challenged throughout 2022. The values of cryptocurrencies declined dramatically in the first half of 2022 causing several companies including Three Arrows Capital and Celsius Network to file for insolvency. This crypto downturn was termed the ‘Crypto Winter’ and despite rebounding somewhat, it, the sector’s wider longstanding regulatory uncertainty and the impacts this could have on the wider economy, has prompted legislators and regulators to consider more stringent controls.

With regards to the UK, cryptocurrencies could challenge insolvency, enforcement and cross-border consistency.

Cryptoassets, under English Law, are considered ‘property’, meaning they form part of a debtor’s insolvency estate, unless they fulfil certain other requirements such as being validly secured, held on trust or removed from the estate prior to insolvency. However, it’s unclear whether cryptocurrency debts would be considered debts or a claim for damages. In an insolvency situation, this could impact a creditor’s recovery and, given the volatility of cryptocurrencies, this impact could be material.

When an instance of crypto lending occurs, typically one cryptocurrency may be used as collateral for a loan in another cryptocurrency. There are numerous issues that present themselves should an enforcement of crypto collateral be required. First, security under English law requires registration within 21 days unless certain limited legal exceptions apply. It’s unclear whether crypto lending would satisfy any exception, not least that registration de-anonymises the parties to a transaction that undermines one of the original values of cryptoassets. Without registration, it’s unclear as to whether any security over such assets would be enforceable by creditors or any appointed receivers, liquidators or other delegates. In addition unwinding a disposal of cryptoassets may be complex where there could be a transaction defrauding creditors, a preference or being a transaction at an undervalue and in usual circumstances, the court would declare such transactions void. Finally, the volatility of the crypto market will also present serious challenges where valuations are required to be sought (including in an enforcement scenario).

Cross-border considerations will also be key where cryptoassets form part of the collateral. The general approach to cryptocurrencies varies between jurisdictions and there are no clear rules as to where jurisdiction in respect of a particular asset will be accepted. This is in contrast to the other security types that are commonly included in banking transactions where jurisdiction is decided largely on the basis of the location of the asset. Cryptocurrencies generally run on distributed ledger technology, which is borderless, and many courts would have the potential to accept jurisdiction. English courts consider cryptoassets’ location to be that as to where a person or company is domiciled but this may not be a universal view. The location of the relevant intermediary account holder could also be indicative when it comes to determining jurisdiction for cryptoassets. With the crypto world being borderless and insolvency and restructuring regimes being siloed, there’s a strong likelihood that cross border co-operation will be required in order to enforce security and recognise judgements.

Sophie Riley is an associate in the banking and finance team and Emily Miller is a trainee associate at Weil, Gotshal & Manges (London) LLP.