FTX Victims Battle the FTX Lawyers for Their Money

FTX customers are slated to get some of their money back. Folks are probably aware of this by this point. In fact, they may get a lot of money back. Certainly, more than was expected in November of last year when the exchange first collapsed.

But an important question remains unanswered in this whole situation, which is that, if you held one Bitcoin on the FTX exchange in November of 2022, when everything went sideways, that one Bitcoin is now worth $44,000. So what do you get back? Do you get back the $16,000 that was at the bottom of the market that probably meant you lost money on Bitcoin? Or do you get back $44,000, which is what it's worth today?

The answer isn't a hundred percent clear yet. And my fear is that as with everything it feels, the retail investors, the small guys, who I would want to be most prioritized as part of this bankruptcy, are of course going to be prioritized the least. And they are going to end up with the short end of the stick holding the bag once again.

Because the truth is U.S. bankruptcies, as I'm coming to learn, aren't designed for small retail players. But those are the people that we should care the most about, the folks who lost money that actually is meaningful to them.

Anyway, that is the topic of today's episode. What is happening with the FTX U.S. bankruptcy? What do the retail players want and what does it look like they're going to get?

Before I dive into all of this, though, if you are enjoying this content, please consider subscribing to the channel, subscribing to the podcast, leaving a comment, leaving a like. I really appreciate it. I'm sorry, this video was a little bit late. I was at my parents, couldn't get the audio to work. So we are doing it again, running it back and we're running it back a little late. But thank you for bearing with me. Let's dive into it.

All right. Backing up for just a moment. There is a fundamental question that needs to be answered when it comes to any of the many bankruptcies that we have seen when it comes to centralized crypto exchanges. And that is who actually owns the cryptocurrency that gets deposited onto an exchange? Does the centralized exchange own that cryptocurrency once it's been deposited? Or does the original owner, the depositor, do they retain control of that cryptocurrency on the exchange?

This matters a lot when it comes to the question that I posed at the top of this episode around does this person get $16,000 back or $44,000 back if they deposited one Bitcoin. And that's because if you assume the exchange owns the crypto, well, then I think there's a little bit more of an anything goes attitude you can have about this whole thing. If the exchange owns the crypto, then they can sell it when they want. They can trade it when they want. They can give you back what they want in theory, right? At least that makes sense to me.

On the other hand, if the individual retains ownership over the Bitcoin, it's a very different story. Suddenly, it doesn't seem like that cryptocurrency should be able to be sold, even if it's in a bankruptcy proceeding, even if it's something like what we see today, where John Ray the third and Sullivan and Cromwell are at the helm of, of FTX. I mean, why should they be able to sell crypto if when by the logic I just laid out it's still owned by individuals, it's not owned by FTX.

Customers of these exchanges call this a property rights issue. Basically, if the cryptocurrency is their property, they as the owners of that property have certain rights that they're entitled to.

And the FTX bankruptcy is not the first in which this issue has been raised. Again, there have been many centralized crypto exchange bankruptcies in the last year and a half. And we can look at precedents set in some of those other bankruptcies.

So Celsius is a good example. While a lot of the headlines around the Celsius bankruptcy were that a judge ruled that Celsius retained control of the cryptocurrency, the truth is actually a little bit more nuanced than that. In fact, the judge in the Celsius case actually looked at the terms of service of Celsius, to make a determination around who owned the cryptocurrency on the exchange. And the answer that he came up with, looking at those terms of service were that, frankly, it depends. Folks who deposited their money as part of the Celsius Earn Program, the high yielding accounts that drew so many people to Celsius and other centralized exchanges, those folks were deemed to have given up control, ownership, etc., of their cryptocurrency when they deposited it.

And Celsius was in control of that crypto at that point. They had ownership of it. They could lend it out. They could do whatever they needed to do. They could generate these fake but seemingly lovely high yields, etc.

And customers had clearly consented to some level of this by depositing them in these earned accounts. By contrast, however, the judge did say that there was a handful of customers, albeit a much smaller group, who had not deposited their crypto into any sort of high yielding accounts on Celsius, but had rather just held them on the Celsius exchange. But by the way, that's like a separate thing. It's like, why? Not clear to me why you would deposit your crypto on Celsius, but not deposit it in like a high yielding account.

In any case, they get the last laugh because folks who did not deposit it with Celsius Earn, who did not deposit it in these high yielding savings accounts, actually got the full amount of their cryptocurrency back. And it was the folks who deposited their money with Celsius Earn who are having to take a haircut on that crypto.

What this all suggests, if you haven't picked up on it so far, is that precedent has suggested that the terms of service for these various exchanges are what should be looked to, to figure out this question around who owns the cryptocurrency and what are they entitled to? Dollar value amounts of crypto at a certain point in time, or the full value amount of the crypto itself at the point in time at which money is being returned.

So with this precedent in mind, let's turn our attention to the FTX bankruptcy now, because the terms of service of FTX are pretty fucking clear. The terms of service for FTX were changed in May of 2022. And they said this when it came to digital assets. They said, "The title to your digital assets shall at all times remain with you and shall not transfer to FTX trading." They said, "None of the digital assets in your account are the property of, or shall, or maybe loaned to FTX trading. FTX trading does not represent or treat digital assets in users' accounts as belonging to FTX trading." LOL. It also said, "You control the digital assets held in your account. At any time, subject to outages, downtime, and other applicable policies, you may withdraw your digital assets by sending them to a different blockchain address controlled by you or a third party." Again, LOL.

In any case, that's what they said. Now, notably, no such language, language this strong, does not appear in the terms of service when it comes to fiat deposits. This really is reserved for cryptocurrency deposits specifically. But it leaves no ambiguity, right? FTX customers who deposited or held cryptocurrency on the FTX exchange were the owners, the sole owners, of that cryptocurrency, and that remained true for as long as they held it.

This would mean, at least logically, that they are entitled to not just the $16,000 that the price of their Bitcoin was worth when FTX collapsed, but the full $44,000 that is the price of Bitcoin today. Of course, the reality is that life is more complicated than that. Bankruptcies, and certainly this bankruptcy, is messier than that.

FTX spent their customers' crypto. That was the fundamental problem. If FTX had all of the crypto that customers were owed and could just be given back to them, we wouldn't be in this situation in the first place.

And the retail creditors, the retail investors that I've spoken with, they understand this. But what these customers want is an acknowledgement from the current bankruptcy estate, from John Ray, from Sullivan and Cromwell, from the folks who are guiding this bankruptcy, that this property rights issue exists and is real, and that there's some sort of compromise or deal that may be able to be struck with folks for whom this particular set of property rights applies.

Specifically, they're not asking for all of their cryptocurrency back. And in fact, bankruptcy law indicates that they have to be paid back in dollars anyway, but what they're asking for is that all creditors be repaid up to the dollar amount valued as of the time of the collapse in November of 2022. But then for everybody who additionally held this crypto that's gone up precipitously in value, that they owned, that they had the property rights over, that attempts be made to backfill them the additional bit that they are owed through something called an RTT, a recovery token, that could be used to give these creditors a stake in future revenues of the company.

So that could come from the venture portfolio like Anthropic and these other big AI investments, or from an FTX 2.0, because it is actually very seriously being considered that FTX be resurrected and restarted. And, you know, aside from the fact that its founders were stealing money from it, it was actually a pretty well functioning, well-liked exchange from a user experience perspective. So it stands to reason that it's possible that FTX actually could make a comeback and generate some real revenues.

And so the folks who owned crypto that were held on the exchange, they're just saying, hey, we would like a piece of that. We would like acknowledgement that paying us back the dollar value of our crypto at the time of the collapse of the exchange, which was the absolute bottom of the market, by the way, because FTX precipitated a further sell-off when it collapsed, like that that is not all that we are entitled to, or all that we are owed.

And this all seems like really reasonable to me, given the law and how it's been interpreted so far in cases. But of course, things at present are actually looking good for this outcome. The FTX estate is expected to put forth a proposal on how some of these issues and how the bankruptcy is to be handled and processed moving forward sometime in the next week or so. December 16th is when it's expected to drop.

But initial drafts that have been seen indicate that the bankruptcy estate is not addressing the property rights issue at all. They're not even engaging on this issue. And they're suggesting that moving forward, the FTX customers receive the dollar value or some percentage of the dollar value of whatever they lost as of November 2022 at the very bottom of the market.

But this isn't the end of the issue. And as we close here, I want to talk about what else these customers are battling because it tells us a lot about the U.S. bankruptcy process. Because see, the retail customers who lost money in FTX are not just battling against the FTX estate for their rights, for what they want. They're also battling other creditors. So let's talk briefly about who these other creditors are and why they seem much more likely to get their way than the customers I've been talking to.

First, there are a number of hedge funds, Attester Capital, Farallon c=Capital, Silver Point Capital, others who bought up claims for really cheap. They bought up claims on the FTX debt at like 10 cents on the dollar. So back in November of 2022, when folks thought nobody's ever getting their money back from FTX, you had these hedge funds that came in and swooped up claims on the debt at like 10 cents.

Well, now those same claims are at like 70 cents. The expectation is that folks are going to get 65, 70, maybe 80% even more of their money back. So anybody who bought those claims is very happy and they don't care if they get the dollar value in crypto back, really. I mean, their return is going to be great. Even if they're just given dollars back, they just want their 600% return.

Then there's another group of creditors. And this is a smaller group, but folks primarily who held larger sums of money on the exchange. And initially it looks like this group, this ad hoc committee as their called, who has lawyers now who are fighting the, the FTX bankruptcy estate. They initially looked like they were going to be fighting for the same property rights issues that the retail customers really care about the folks that I've been talking about.

But as time has gone on, what's become clear is that this ad hoc committee is really using the property rights issue as a leverage to get the estate to yield on other issues, specifically, a set of special interest issues around clawbacks and what the timeframe in which clawbacks can happen and the percentage at which they can be clawed back, whatever. It's not even worth getting into the details on that. The point is there is a narrower group of people that this particular set of issues affects and that's what this group is really fighting for.

But because apparently there was a group of creditors who had a lot of money on the exchange and who continue to be rich people who have a lot of money, they've been able to afford the startup costs to hire lawyers to fight for this narrow set of issues that the broader retail community really doesn't care about because it doesn't affect them. And in that way, they feel like this group that initially was supposed to be representing them as well in some ways, has sort of abandoned them and abandoned the property rights issue that this particular group cares the most about.

Now to add insult to injury, the legal fees of this ad hoc committee, the one that's being represented by Evershed Sutherland, those legal fees are now being covered by the bankruptcy estate, i.e. the creditors' money. So the legal fees for this group of creditors that represents a very specific and narrow set of interests, literally special interests, are getting their legal fees covered by the FTX bankruptcy, i.e. all the rest of the creditors, all of the creditors in total are paying for those law fees.

In short, the problem with all of this is that both the hedge fund creditors and this ad hoc committee creditors, these folks have money. So in the case of the hedge fund folks, they've bought up a lot of the FTX debt, which gives them a lot of voting power when it comes to what ultimately will happen and ultimately getting approval for whatever the bankruptcy process is going to be.

On the other side, you have the ad hoc committee who have a lot of money, so they've been able to pay the upfront cost of hiring these lawyers. Now, of course, their legal fees are being paid elsewhere, but initially it costs money to hire these lawyers and they couldn't be sure that the estate was going to pay for their legal fees. So in any case, they had the capital to hire lawyers to fight for their specific set of interests.

So the interests that are being left behind, the interests that aren't being heard, are those of the people with less money, less resources. And the concern is that they're going to have the least amount of say in this whole process, despite the fact that I think many of us would agree, those are the people we'd most want taken care of. Those are the folks who were hurt the most. Those are the people who lost things like life savings, things that actually mattered, the stuff that's really gut wrenching to lose.

I spoke with an FTX creditor, Pat Wabbit, about these issues.

<Audio Clip of Pat Wabbit> -  "The issue with the US bankruptcy process, as I've come to realize, is that it really isn't designed for retail people like me, and so we can't afford access to that type of justice, and this is the issue. Bankruptcy, US bankruptcy process is meant and designed for big players, which obviously you can see where there might be problems with that,".

Now, this doesn't mean that these smaller retail players can't and won't continue to fight, because they will. And there are folks that have mobilized, especially on Telegram, they're in group chats, and it does seem like this is a fight that they really want to push. They want a lawyer up. It's possible they could get their own legal fees covered by the bankruptcy estate, but this is sort of the catch 22 in all of this, is even if they get their legal fees paid for, continuing this fight is only going to prolong this process, and this is one of the most expensive bankruptcies, in relative terms, of all time. I'll speak more about this probably in other episodes that I plan to put out kind of soon, but it is just staggering the amount of money that is being spent on a daily basis as part of this bankruptcy.

And so this is the bad situation in which these retail investors find themselves, which is that for every day that this gets dragged on, for every day that they prolong it with their own fight, they're actually just dipping into their own coffers. That money is really theirs, and it's being paid to drag on these fights, whether it's covering their legal fees or the ad hoc committee's legal fees, or most of all, the investment bankers, Sullivan and Cromwell, John Ray the Third, all of which who are managing this bankruptcy and charging a huge sum of money to do so.

And so at the end of the day, they're going to have to decide, is this worth it? What is this fight worth to folks? Personally, I care about this from a personal standpoint. I actually do care about the victims of all of these different kinds of scams. And I also care about it on principle because I do think the logic behind why they control this crypto is pretty sound. And while I also understand why logistically it's not feasible to pay every person who held crypto on the exchange, the exact dollar amount that that crypto is currently worth, I do fully agree that there should be some wiggle room here. There should be some discussion at least of this issue, some acknowledgement of this issue from the current FTX bankruptcy estate.

All right, folks, if you enjoyed this episode, like I said, please do consider subscribing to the channel, leaving a comment, leaving a like, subscribe on the podcast. You know, I really like knowing what you think would love to know your views on this particular issue. And with that, I will see you next time.