The crypto rout continues in unexpected ways every month. This month, FTX is driving down the market as the company implodes and the effects ripple across many cryptos’ prices. In fact, FTX’s implosion has been so bad, it has driven the company into Chapter 11 bankruptcy. It’s certainly not the first crypto company to find itself in this position in 2022. But, it is the most high profile. The news has investors wondering what this bankruptcy protection is. And, many want to know what it means for the future of Sam Bankman-Fried’s crypto empire.
Heads began turning toward Bankman-Fried’s network earlier this month, when his private equity company Alameda Research’s balance sheet was unveiled publicly for the first time. It showed that the company was heavily reliant on its sibling company FTX’s flagship token. In fact, it held over $6 billion worth of the token.
Seeing as the token only had a market capitalization of $3.4 billion on Nov. 1, a day before this report came out, its holding was entirely illiquid. Selling such a large stake would crater the crypto’s value. When whale owner Binance (BNB-USD) began selling its own holdings of the token, FTX underwent a liquidity crunch that it couldn’t get out of.
The story is highly reminiscent of the Terra (LUNA-USD) collapse in May, and it is nearly an identical turn of events. Like FTX, Terra relied heavily on printing its own collateral. It did not hold nearly enough liquid LUNA to cover a mass investor exit. And also like FTX, Terra folded as a result of the collapse. Just today, Bankman-Fried announced he would be stepping down as CEO. The company also made its initial filing for Chapter 11 bankruptcy protections.
Chapter 11 Bankruptcy: What It Means for FTX
The Chapter 11 bankruptcy proceedings leave much uncertainty for FTX users. What might happen to their assets? How and when can they get these assets back? Will FTX cease to exist? Luckily, there is an answer to many of these questions.
As stated earlier, FTX is not the first crypto company to file for Chapter 11 bankruptcy protections. When Terra fell apart earlier in the year, several crypto-investing companies’ investments tanked. After missing a multitude of margin calls from lenders, three companies fell into bankruptcy. Two of these, Voyager Digital and Celsius, filed for Chapter 11 bankruptcy.
Chapter 11 bankruptcy is a bit different from other bankruptcy protections in that it means there is hope for filers that they may turn their business around. Most bankruptcy filings typically involve simply liquidating assets and closing shop. However, Chapter 11 filers work with the court on structural reorganization. In the first 120 days after filing, a filer has the right to produce a document to the court. This document outlines a reorganization plan for a company to pay off its creditors and resume operations.
In July, just after filing its own Chapter 11 bankruptcy protections, Celsius proposed a crypto mining reorganization plan, in which the company opened a facility that mined crypto and paid revenue to creditors. As with other bankruptcy protection filings, FTX will provide its assets, liabilities, expenditures and a full statement of its financial affairs to the court. This will allow investors to see the full scope of its woes.
Unfortunately for FTX users, crypto bankruptcy filings typically see client assets frozen for long periods. Both Voyager Digital and Celsius still have their assets frozen by the companies, which filed back in July. And for those hoping to see the exchange rise again, Chapter 11 protections aren’t typically very successful. Only about one in every 10 Chapter 11 filings has been successful. So, there is a chance FTX makes it out of this bankruptcy alive, but it’s an awfully slim one.
On the date of publication, Brenden Rearick did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.