The dramatic collapse of cryptocurrency exchange FTX has been compared to the collapse of Lehman, Enron and the Bernie Madoff scandal.
And just like in these cases, crypto-infused lawyers know “there will be a lot of work.”
These are the words of Anthony Casey, professor of law at the University of Chicago and former practitioner specializing in bankruptcy law. He said Fortune that years of crypto bankruptcy await.
FTX filed for Chapter 11 bankruptcy and announced the resignation of Sam Bankman-Fried as CEO on Nov. 11, after he was accused of mismanaging client funds on the exchange and using them to fund the operations of the commercial company Alameda Research, another company he founded.
Bankman-Fried could face jail time if convicted of fraud and would be held “under watch” by local authorities in the Bahamas, where FTX is based. But the implications of the FTX fallout are expected to reverberate much further than the company’s former executive. In an updated bankruptcy filing this week, FTX revealed that insolvency could affect more than a million people and businesses who are now owed money from the stock exchange, which is missing currently between $1 billion and $2 billion in customer funds, according to Reuters.
With numbers like that, legal experts say Fortune FTX’s bankruptcy alone could drag on for years and trigger a major industry meltdown. And while this is bad news for countless people and businesses who have invested in cryptocurrencies, the legal profession is about to have a blast.
“Everyone is learning about crypto bankruptcy right now, and I think there’s a lot of work that will be out there on how to handle crypto bankruptcy,” Casey said.
An “unprecedented” failure
The sheer scale of FTX’s collapse could trigger enough lawsuits to be compared to some of the biggest bankruptcies in history, according to Casey.
“A lot of law firms are going to be on this case,” he said. “If it’s bigger than Enron and messier, it’s going to be one of the most complicated fraudulent bankruptcies ever.”
Bankman-Fried was replaced as interim CEO by John J. Ray III, an attorney who presided over several high-profile insolvencies, including Enron in 2002, after the energy company was accused of fraud and false accounting. Ray was tasked with liquidating Enron’s assets and distributing them to defrauded creditors, but he says even that scandal doesn’t compare to the task ahead of him at FTX.
“Never in my career have I seen such a complete failure of corporate controls and such a complete lack of reliable financial information as has happened here,” Ray said of FTX’s accounts in a bankruptcy filing on November 17, calling the situation “unprecedented”.
Among the most concerning aspects of the company’s finances, Ray cited the lack of a functioning corporate governance structure, missing or non-existent bank account information, and the misuse of company funds to pay for homes and other items for FTX employees. He also criticized the lack of a real board for the company, where most decisions were made by a group of “inexperienced, unsophisticated and potentially compromised individuals”.
“Other crypto companies will have to pay attention to their corporate structures and governance, otherwise there will be a lot of problems. I think this is going to be an example for other crypto companies,” said Jiaying Jiang, a law professor at the University of Florida’s Levin College of Law who specializes in blockchain and cryptocurrency. Fortune.
Liquidators found evidence of “serious fraud and mismanagement” at FTX, which is likely to lead to multiple lawsuits against the company, several law professors, former prosecutors and in-house counsel said. Fortune.
But while most of the legal attention will likely focus on FTX in the near term, it is almost certain to open a Pandora’s box for the crypto sector. The collapse of FTX sparked widespread contagion fears in the industry, with many other companies at risk of collapsing.
Prior to FTX, other meltdowns this year included Celsius, BlockFi, and Voyager Digital. As the latter two were both bailed out by FTX, their potential bankruptcies are a major possibility in the future.
Even Changpeng Zhao, the CEO of FTX rival Binance, which arguably caused its competitor’s downfall when it launched a run for FTX assets, warned that the FTX crash could have “cascading effects”. on the industry as a whole.
Fears of contagion
Law firms of all sizes have been steadily expanding their digital asset, cryptocurrency and blockchain practices for years, but the scale of the FTX implosion could accelerate that, bringing many more lawyers into bankruptcy and litigation in the crypto sector.
Law firms often operate on the basis of supply and demand, said Yuliya Guseva, a law professor and head of the Blockchain and Fintech program at Rutgers Law School. Fortune. Ahead of the crypto winter of 2022 – when the values of virtually all cryptocurrencies plummeted – Guseva said there was much more demand for “transaction-side lawyers” or legal practitioners who could facilitate projects and investments. crypto-related trading.
But the steady downturn in cryptocurrency fortunes this year has dampened lawyers’ interest in deals and ventures, Guseva said.
“As more companies fail this ‘winter,’ there could be more litigation against crypto companies,” she said, adding that more bankruptcy and litigation experts should enter the crypto space in the coming months.
“The failure of FTX just becomes a signal for these groups to pay more attention to crypto. I think that’s what we can expect in the current climate,” Guseva said.
Three law firms contacted by Fortune declined to comment, citing their own potential business interests after FTX’s collapse.
“In the coming months, more and more crypto companies will go bankrupt. It’s very likely,” Jiang said. “And of course the lawyers are going to do their thing and take care of all these cases.”
Paradigm shift
In the wake of FTX’s collapse, many longtime blockchain technology advocates, including Binance’s CZ, Microstrategy founder Michael Saylor, and Crypto.com exchange CEO Kris Marszalek, have come forward to say that the time had come for stricter regulations to protect the industry against crashes of the ilk of FTX.
“Now regulators are rightly going to scrutinize this industry much, much harder, which is probably a good thing, to be honest,” CZ said the day FTX filed for bankruptcy.
With a case as big as the collapse of FTX, experts say regulation and tighter government control over the industry is likely to follow.
“It’s still early days, but this will be one of the biggest fraud-driven bankruptcies we’ve seen,” said Jared Ellias, a Harvard law professor and corporate bankruptcy expert. Fortune. “When you have big fraud or bad behavior from a big company, history teaches us that you have regulatory responses.”
Critics have accused the Securities and Exchange Commission, the main regulatory body in the United States, of failing to protect users from the many crypto-related meltdowns of the year. A Washington insider recently said Fortune that SEC Chairman Gary Gensler was “in a corner” with Congress, where lawmakers would demand answers about how his agency could have missed the fraud committed by FTX.
The need for increased crypto regulation was highlighted by Treasury Secretary Janet Yellen in a recent statement, saying that the FTX collapse and its widespread impact demonstrated “the need for more effective oversight of crypto markets. cryptocurrency”.
Critics, however, argue that crypto should not be regulated, as this would spread crypto contagion into the mainstream economy. Nobel Prize-winning economist Paul Krugman recently wrote that crypto has so far “virtually made no inroads into the traditional role of money” and pointed out that crypto exchanges would be virtually indistinguishable from banks. traditional in a more regulated regime. Similarly, economists Stephen Cecchetti and Kim Schoenholtz wrote in a recent FinancialTimes editorial that “it’s much better to do nothing and let the crypto burn.”
Regardless of the regulatory future, the number of bankruptcies is likely to accumulate. In this year’s crypto winter alone, over 12,000 cryptocurrencies all but ceased trading while remaining active, becoming so-called “zombie” coins.
Either way, lawyers will thrive. “If there’s going to be regulation, there’s work for lawyers,” said Casey of the University of Chicago. Harvard’s Ellias said the next few months for crypto lawyers could be the equivalent of a “gold rush”.
Regulation could mean that demand for lawyers in the blockchain and crypto space continues beyond bankruptcy and litigation as the focus returns to compliance and commercial projects, Paul Strickland, legal counsel at the firm of federal defense Oberheiden PC, which advises clients on issues related to blockchain and government investigations, says Fortune.
“I hear that from a lot of my clients who say, ‘We want to follow the rules, we just don’t know exactly what they are,'” Strickland said, adding that a more regulated environment ” could boost the overall growth and legitimacy of the industry.
But as the extent of the damage from the FTX crash becomes clearer over the next few months and zombie crypto firms are weeded out, insolvency lawyers are likely to be in much greater demand.
“I think by the end of the year, many bankruptcy lawyers will know a lot more about crypto than they do today,” Harvard’s Ellias said.
This story was originally featured on Fortune.com
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