FTX Crypto Exchange Collapse and Legal Options for Investors Explained

The multi-billion-dollar collapse of crypto exchange FTX is the latest in almost a century of financial crises, says Syed Rahman, crypto specialist at Rahman Ravelli. But, he explains, there are ways for investors to try and regain what is theirs.

If hindsight were a commodity, it would always hold its value.

The financial markets are always looking for the next great investment opportunity. Yet many within those markets will always put their faith in the supposed safe bets. And while cryptocurrency can be seen as the former, the chance to use hindsight to identify one of the latter offerings would surely be grabbed by many investors. With the headline-making, massive collapse of FTX now wreaking havoc, there must be many in the markets who wish they could have had the benefit of hindsight before placing huge amounts of money and faith in a crypto exchange that now owes billions.

The fall of FTX is a modern-day financial crisis. The assets it handled are a relatively new concept and its rapid growth (and speedy fall) epitomise what many have come to see as both cryptocurrency’s appeal and its risks. Yet despite this being a crypto-related problem, it is essentially nothing new. It is the latest in a long list that started with the US and UK stock market crashes of 1929 and whose most recent additions include the bursting of the dot-com bubble over 20 years ago and the 2008 financial crisis. If anything, the 2008 crisis has parallels with FTX. FTX’s financial relations with its owner’s hedge fund Alameda Research echo the high-risk, profit-hungry (and hugely damaging) deals that the financial institutions pursued a decade and a half ago.

Once FTX’s investors were scared, they started to run. They rushed to withdraw $5 billion at a time when FTX had less than a fifth of that in assets but $9 billion in liabilities. Their behaviour has been seen – in the “real world’’ -whenever there has been a run on a bank. And, once again, it has raised the issue of whether financial institutions – crypto-related otherwise – should be able to act in such a speculative manner.

The FTX saga can be viewed, therefore, as a relatively new twist on an old problem. Crypto is simply the latest class of asset where – apparently, at this stage - a lack of regulation and excessive risk taking has seen another very attractive bubble burst. But what needs to be remembered is that there are routes that can be taken by those who are looking to recoup what they put into FTX.

One possible route is international arbitration. There are clauses within FTX’s user terms that provide for any disputes to be resolved by international arbitration. This may be difficult as, generally, creditor collection activities against a bankrupt debtor (including arbitration proceedings) are stayed – meaning they are halted - by 11 U.S.C. 362 of the US Bankruptcy Code, to give the debtor a chance to fully assess their financial situation. Yet, against this, there may well be arguments that the crypto assets in question being held on trust by FTX, meaning they are not covered by the automatic stay that FTX’s US filing for bankruptcy has prompted.

There are also investor state considerations. FTX’s parent company, FTX Digital Markets Ltd, is a Bahamas-based entity and FTX recently put out a statement explaining its accounts had been frozen by the Bahamian authorities. But withdrawals by Bahamian-registered accounts should still be allowed. This is because the Bahamian Provisional Liquidator, appointed by the courts, has stated that FTX is a Bahamian entity and so it should consequently be administered under Bahamas law, not by US law.

As with many crypto-related issues, there is the possibility of employing freezing Injunctions in relation to FTX. It has been reported that approximately $650 million was hacked and dissipated from FTX last week. In such circumstances, there are proven procedures in place for conducting a tracing exercise and then potentially obtaining worldwide freezing orders to prevent the assets in question being moved. We have done this in the past, which has led to precedent-setting cases (Ion Science v Persons Unknown and Fetch ai v Persons Unknown), and it has to be viewed as an option by those considering how to regain what is theirs from FTX.

The FTX collapse is big news for a number of reasons. But the issues at the heart of it are not new. Which is why there are options available to those who are affected.