Another domino has fallen.  Earlier this year, we wrote about the challenges facing the crypto industry that resulted in the bankruptcy filings of Three Arrows Capital, Celsius Network, and Voyager Digital. We noted that other crypto entities could also end up in chapter 11, and that prediction has proven correct.

On November 11, FTX Trading LTD and approximately 130 of its affiliates filed voluntary chapter 11 bankruptcy petitions in Delaware.  FTX operates the world’s second largest cryptocurrency exchange and was valued earlier this year at $32 billion.  The FTX filing estimates the debtors’ liabilities at between $10 billion and $50 billion, and while the number of creditors is estimated at over 100,000, the actual number could be over one million.

FTX’s bankruptcy filing may push the so-called crypto-winter into a full-blown ice age by causing even more crypto companies to fail, but some experts say the fallout may be more limited.  One thing is for certain—Voyager Digital’s case has been derailed.  Just last month, the bankruptcy judge in Voyager Digital’s case approved its sale to FTX, which formed the basis for Voyager Digital’s proposed chapter 11 plan.  With FTX’s filing, Voyager Digital has said this transaction will not occur. 

FTX’s bankruptcy is a freefall bankruptcy, meaning there is no immediate plan for FTX’s exit from chapter 11.  This type of chapter 11 filing has become less common over the last decade while so-called prepackaged cases – where a debtor files chapter 11 with a pre-negotiated plan of reorganization – have become increasingly popular.  Prepackaged cases are preferred by would-be debtors because these cases are quicker, simpler, and cheaper.  Both the Celsius and Voyager Digital cases are also freefall bankruptcies.

However, FTX also didn’t file many of the motions that debtors typically file on the first day of a case.  These motions often seek an array of emergency relief, such as the ability to use cash collateral or to continue paying employees.  These motions have an important stabilizing effect on a debtor’s business, and are often used to send a reassuring message to vendors, employees, clients, and other interested parties.  FTX’s failure to file these emergency motions is, therefore, noteworthy.  In one of the only first day motions filed, FTX explained that the filing was done on “an emergency basis” and previewed that requests for additional relief would be forthcoming.  Further emphasizing the emergency nature of this case, FTX also asserted that barely over a week before the filing it was one of the most respected companies in the crypto space.

FTX’s sudden financial woes can be traced back to November 2, when it was reported that a large number of FTX’s native cryptocurrency tokens, FTT, were held by a hedge fund run by FTX’s co-founder and CEO.  The close financial ties between the two companies had not been previously disclosed.  This new information caused FTT’s price to plummet while customer withdrawals from FTX’s platform surged.  Reports said that traders pulled approximately $6 billion from the platform in just three days.  Customer withdrawals were frozen on November 8. 

This may sound like déjà vu all over again since the rush of customer withdrawals (akin to a run on the bank) followed by a freeze in customer accounts is eerily similar to what happened in this year’s earlier crypto filings.  For a brief moment, however, it seemed that FTX might escape bankruptcy through a sale to a competitor.  But that deal fell through at the due diligence stage—yet another sign that all was not well with FTX’s business.  As more and more questions were raised regarding FTX’s leadership, the company’s CEO stepped down from his role.  A new CEO was appointed to take over, one who has vast experience running troubled companies in chapter 11 cases.  He and the professionals he retained immediately began working around the clock put the FTX companies in bankruptcy.

In another twist, one day before the chapter 11 filings, government regulators in the Bahamas, where many of FTX’s key employees were located, put one FTX entity (an entity that is not a chapter 11 debtor) into insolvency proceedings under the authority of government-appointed liquidators.  On November 15, those liquidators filed a cross-border chapter 15 case in the bankruptcy court for the Southern District of New York.  That filing was separate from the ongoing chapter 11 cases in Delaware, and done without coordination or consultation with FTX’s new CEO.  After the chapter 15 case was filed, FTX filed a motion in the Delaware court to have the chapter 15 case transferred to Delaware.  That motion will be heard by the Delaware court on November 22 and, in the meantime, the New York court has not granted any substantive relief in the chapter 15 case. 

In addition, FTX has reported that it has been in contact with the U.S. Attorney’s office, the U.S. Securities and Exchange Commission, the U.S. Commodity Futures Trading Commission, and other federal, state, and international regulatory agencies.  The filings of Voyager Digital and Celsius triggered similar investigations into the circumstances surrounding their bankruptcies.  The court dockets also saw a deluge of letters written by mom-and-pop investors who could lose all they put into the company—sometimes consisting of their entire life savings.  For these creditors, the regulatory investigations, conducted after a company has already imploded, may prove too little too late.

In sum, this crypto collapse is yet another reminder that more regulation is needed in the crypto space.  Proper government regulation should help prevent fraud and misuse of customer funds, as well as establish a bankruptcy regime to avoid panic among investors.