FTX users may be in a better position to reclaim their assets than in previous crypto busts
FTX filed for bankruptcy last Friday, capping an incredibly volatile week that saw the fourth-largest global cryptocurrency exchange collapse in a breathtaking fashion.
Approximately 130 FTX-affiliated companies, including the US arm, were included in the Delaware Chapter 11 filing, while the Bahamas arm of FTX filed for Chapter 15 bankruptcy in the US Southern District of New York.
A Chapter 15 format allows foreign representatives of FTX — in this case, liquidators appointed by the Bahamas Supreme Court — to seek recognition in the United States of pending foreign bankruptcy or liquidation proceedings.
But while FTX has opted to file for Chapter 11 — as dozens of companies do each year — what’s next for the company and its investors and customers is far from clear. Although Celsius and Voyager, two failed US crypto firms, filed for bankruptcy earlier this year, the courts have made limited progress and provided little clarity on customers’ legal rights in crypto-related bankruptcy cases.
Typically, in corporate bankruptcies, creditors with secured claims – mortgages, liens, etc. – or creditors with preferential status (e.g. workers with arrears on wages or the IRS demanding back taxes) are first to seek to recoup their losses, followed by investors. and then customers and those with unsecured receivables.
In the Celsius and Voyager cases, it was argued that an exchange’s funds, including client assets, could be seized by an administrator to pay off its debts. In this scenario, customers would likely become unsecured creditors, meaning they would be at the bottom of the line of those seeking a refund.
FTX is not like other crypto busts for users
FTX clients may be in a better position than previous failed crypto firms. That’s because under the FTX User Agreement, account holders retain right and title to their property — those assets never became FTX property, says Miles Fuller, head of government solutions at TaxBit, a tax and accounting firm Cryptocurrency accounting software.
In particular, the User Agreement of the FTX US Terms of Service, last updated September 16, 2022, states: “The ownership of the cryptocurrency represented in your FTX.US account remains with you at all times and is not transferred to FTX.US.”
Additionally, Section 8.2.6 of the FTX.com User Agreement states that “You control the Digital Assets held in your Account. None of the digital assets in your account are owned by FTX Trading or are intended or permitted to be lent to FTX Trading; FTX Trading does not represent or treat digital assets in user accounts as property of FTX Trading.”
It’s worth noting that clients who opted into a returns program weren’t under the same protections and therefore, according to Coindesk, those assets could be considered FTX property in bankruptcy proceedings.
“It’s definitely different than what we saw earlier this year with things like Celsius and Voyager. These platforms had accounts [agreements] that clearly said the opposite,” says Fuller. “So that’s a different matter — and even the bankruptcy attorney community is debating how that’s going to play out.”
If the assets that FTX deposited on the platforms are found to still be client assets, that means they’re not owned by the exchange and won’t become part of the bankruptcy — they would have to be returned, Fuller says.
The Terms of Use can only be the starting point
If these terms of service are followed, it could be a big deal for customers. Instead of getting pennies on the dollar for the value of their crypto and other assets as unsecured creditors, users could get everything back in what is escalating into a lengthy and drawn-out process before FTX’s creditors can split up what’s left of the exchange’s assets . Of course, that assumes FTX still has customer funds after hackers stole nearly $400 million from the firm on Friday night. Reuters has also reported that at least $1 billion is missing from FTX client funds.
This also presupposes that the terms of use are observed. FTX’s bankruptcy creditors will likely argue that clients retain their rights. To make matters worse, FTX appears to have violated its own terms of service when it allegedly transferred client funds from FTX to Alameda Research.
If the terms have already been breached and client funds have been mixed up, it might be easier to argue that clients have no rights to those funds and classify FTX users as general unsecured creditors.
If this all seems bleak, that’s because it is. Indeed, on Wednesday, Sens. Elizabeth Warren (D-Mass.) and Dick Durbin (D-Ill.) sent a letter to founder Sam Bankman-Fried and John Jay Ray III, FTX’s newly appointed CEO, demanding answers. “One thing is clear: the public is owed a full and transparent account of the business practices and financial activities before and after the collapse of FTX and the loss of billions of dollars in client funds,” lawmakers wrote.
There is a lot to clarify for the bankruptcy judge, but one thing is certain: there will be no quick solution. “It’s going to be a while before that gets settled and we’ll see what comes of it,” says Fuller.
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