FTX has warned its investors, customers and the crypto-world that they may have to file for bankruptcy protection without rescue financing to address its immediate liquidity crisis. Unlike the bankruptcy cases of Celsius and Voyager, FTX’s case, should it file, will likely involve many institutional investors with secured and unsecured claims. These institutional investors are now having to take steps to limit their exposure in the face of such uncertainty while considering the consequences of an FTX filing. While history rarely repeats itself, it does rhyme quite often, and lessons learned from Lehman’s epic bankruptcy in dealing with securities trades, loans, swaps, repos, customer property and dozens of other structured transactions may be useful guidance. Of course, adding the novelty and complexity of digital assets and absence of regulatory clarity, an FTX case could be a tangle of confusion.

The legal questions that investors will face include:

  1. How will my digital assets or investments be classified in an insolvency proceeding?
  2. In a US Bankruptcy proceeding, do any traditional safe harbors apply which would allow termination, liquidation and set-off of claims?
  3. How will my claims or assets be valued?
  4. What should a counterparty do with any collateral they hold?
  5. What are the risks of withdrawing my digital assets today (assuming I still have access)?
  6. Do I have any legal recourse against management in connection with my potential losses?

This is a gut check moment for institutional investors in the cryptocurrency space and may be the first real test of how market, counterparty and legal risk management should respond to these types of events in digital asset investing and trading.

FTX’s insolvency will have repercussions on Voyager as well. As has been widely reported, Voyager’s exit from Chapter 11 is premised on the consummation of a sale of substantially all of its assets to FTX US (or West Realm Shires, Inc.). Very generally, under the transaction FTX US would acquire the cryptocurrency on the Voyager’s platform and pay additional consideration which the company estimated to provide at least approximately $111 million of incremental value. In its disclosure statement, the company reported that “the FTX US bid can be effectuated quickly, provides a meaningful recovery to creditors, and allows the Debtors to facilitate an efficient resolution of these chapter 11 cases, after which FTX US’s market-leading, secured trading platform will enable customers to trade and store cryptocurrency.” After this week’s news of FTX’s severe liquidity constraints and its own bankruptcy risk, Voyager’s prospects for a quick wind-down, and the associated recovery for customers and other creditors, have dimmed considerably.

It has been reported that Binance was a leading competitor of FTX US for Voyager’s assets. Binance has now backed out of any purported agreement to provide rescue financing to FTX, leaving FTX US’s ability to close on its acquisition in grave doubt. If unable to close, Voyager will surely look to Binance to revisit their interest in the platform. While this will certainly cause a delay, the framework of Voyager’s plan to exit bankruptcy may hold.

The excitement in the distressed digital assets markets may only be in the early innings.