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Customers who trusted crypto giant FTX may be left with nothing

New York
CNN Business

As the dust settles from one of the most shocking financial meltdowns in history, one of the key unknowns is how much customers who can’t access their money expect to get back from FTX, the crypto exchange that filed for bankruptcy last week has.

The answer, according to legal experts, could be zero.

Before its debacle, FTX.com marketed itself as a safe-for-beginners destination for buying and selling cryptocurrencies. But a liquidity crisis last week forced FTX to halt withdrawals, leaving clients and investors in limbo. FTX allegedly used customer funds to support its sister hedge fund’s high-risk trading operation without permission, according to the Wall Street Journal.

On Friday, FTX and the hedge fund, Alameda Research, filed for bankruptcy.

Federal prosecutors in New York are now investigating the stock market’s collapse, a person familiar with the matter told CNN. And authorities in the Bahamas, where FTX is based, launched a criminal investigation into the firm over the weekend.

The legal ramifications for FTX and its founder, Sam Bankman-Fried, remain unclear. But as the stock market, once valued at more than $30 billion, collapses, it looks increasingly likely that customers who handed over their money to FTX could be left holding the bag.

“We just don’t know the extent of contamination,” said Howard Fischer, a partner at the law firm Moses Singer and a former Securities and Exchange Commission attorney. “The first ring of victims are the people who held assets in FTX … They’re probably not going to be made whole, or anywhere close to that.”

There are a few reasons for this.

In a traditional American bank failure, the government insures customer deposits, making them whole up to $250,000. But there is simply no mechanism for depositor insurance in the largely unregulated world of cryptocurrencies.

In theory, FTX’s customers should get a cut of what’s left of the company’s assets at the end of the bankruptcy process. But so far, at least, it’s not clear how much will be left to pay out.

“As far as I know, they have two assets – the goodwill of the exchange and the value of their FTT coins,” said Eric Snyder, head of the bankruptcy department at law firm Wilk Auslander. (Goodwill value refers to intangible assets such as a brand’s reputation and intellectual property. And FTT coins, the crypto token issued by FTX, have lost more than 90% of their value in the past week.)

In bankruptcies, Snyder explains, there’s a fairly simple formula for figuring out how much creditors — in this case, FTX depositors — will receive.

“The numerator is the assets, the denominator the liability. You divide the one into the other, and the [result] is what everyone gets,” he said. “But if people take out all the assets, there’s not going to be much of a counter.”

He added: “It is very conceivable that the return will be minimal at best.”

Of course, the sudden demise of FTX makes it a difficult case to judge early, lawyers say.

Normally, companies will have weeks to prepare bankruptcy filings that disclose, among other things, an explanation of why the company sought Chapter 11 protection and what it intends to accomplish in bankruptcy court.

Dan Besikof, a partner at Loeb & Loeb who specializes in bankruptcy, says it’s too soon to say whether clients will get any money back.

“All you can really do is guess from tweets where things stand,” he said. “And how customers get their money back can depend on many different things, including which entity they hold the money through, how many of the coins are left.”

The FTX fallout has rattled the entire crypto industry, raising serious questions about the future of digital assets and the lack of global regulation.

On Monday, Changpeng Zhao, the CEO of FTX rival Binance, sought to reassure his audience of the sector’s legitimacy.

“Obviously people are nervous,” Zhao, widely known as CZ, said in a question-and-answer session on Twitter. “I mean, short term it’s painful. But I think it’s actually good for the industry in the long term.”

The giant crypto exchange briefly emerged as a lifeline for FTX before reversing course last week.

Zhao, whose tweet announcing Binance’s divestment into FTX helped fuel the smaller firm’s liquidity crisis, denied having a “master plan” to expose FTX. Yet critics note that the biggest, and perhaps only, winner in the demise of FTX is none other than Zhao, now arguably the richest and most influential player in digital asset trading.

“As much as some people blame me for blowing the whistle or popping the bubble, I apologize for that … I apologize for any turmoil I’ve caused. But I think any time, if there’s a problem, the sooner we reveal it, the better.”

—CNN Business’ Matt Egan and Kara Scannell contributed to this article.

Correction: An earlier version of this article misstated the name of the law firm Loeb & Loeb.

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