Published: November 22, 2022

2021 signaled a new frontier in financial technology as NFTs, cryptocurrency, and more both exploded in terms of value and consumer interest. But what goes up must come down, and many crypto purveyors are falling from grace faster than the value of Luna coin this past May. Earlier this year, we watched a set of stablecoins crash as Bitcoin and Ethereum prices plummeted. Ever since, token values have remained in flux and have prompted government entities to move fast on making market regulations to stop further illicit activity. But last week, we were shown that crypto’s reckoning is just starting. FTX, one of the world’s largest crypto exchanges, imploded, prompting bankruptcy and their once ‘wunderkind’ CEO, Sam Bankman-Fried, to resign.

Resignation didn’t save Bankman-Fried and FTX from further damage; instead, they are now being sued in a consumer class action suit worth $11 billion. Let’s take a quick look at what the impending dispute entails, how litigation in the crypto world may evolve as a result, and why engaging with experts early would be a smart move.

The FTX Legal Fallout

Once the second largest cryptocurrency exchange platform only triumphed by Binance, FTX was run by the well-known, well-connected, and well-educated Bankman-Fried (commonly referred to as SBF). Prior to launching FTX, SBF first created his own trading house, Alameda Research. At the start of this year, investors had valued FTX and its operations at a combined $40 billion, and SBF’s wealth was reported to exceed $16 billion at its highest in March. This success led him to be heralded as a modern J.P. Morgan and to everyone in the finance world, it seemed like he was crypto’s golden child. But despite his claims that his empire was immune to the crypto crashes that killed Luna, the price drops greatly affected his operations-specifically at Alameda. And thus began his downfall.

Amid ongoing industry-wide bankruptcies, Alameda lenders became spooked and wanted to pull their contributions. But since Alameda began borrowing money from FTX in attempt to stabilize the industry during the stablecoin crashes, the company was no longer liquid, prompting them to start borrowing from FTX’s customer deposits to bail itself out. And to help cover up this bailout, SBF also began trying to cover their losses with FTT, FTX’s proprietary coin. This led to the collapse of an even more important relationship with their main competitor: Binance. After Binance CEO decided to liquidate their FTT, investors rapidly pulled approximately $6 billion from FTX and demolished the value of the token, pushing SBF to seek investors to help bounce back from the massive withdrawals. They all declined, and after Binance refused to buy the failing company, FTX and Alameda filed for bankruptcy on November 11th. The once $31 billion company froze trading and customer assets, seeking to discharge more than 1 million creditors in court.

Since, criminal and regulatory bodies like the U.S. Attorney’s Office and the SEC have been digging into the company’s activity, and a class action has been filed by investors. What will these investigations and suits look like?

The Class Action

As we know, the crypto world is a widely unregulated space that currently operates in its own corner of the finance world. The exchange of funds between Alameda and FTX would not have happened in a more traditional financial market; in regulated spaces, investing with consumer funds is illegal and there are authorities in place to prevent the loss of depositor investments. Investors in this space have few protections and FTX’s bankruptcy filings report that more than 1 million investors along with multiple funds and start-ups have assets tied up in the newly crashed company.

One of the first of many projected investor suits brought against the exchange was filed in Miami against SBF and celebrities like Tom Brady, Gisele Bündchen, Stephen Curry, and a whole slew of other big names. The filing seeks to penalize “all parties who either controlled, promoted, assisted in, and actively participated in FTX Trading and FTX US (collectively, the “FTX Entities”), offer and sale of unregistered securities in the form of yield-bearing accounts (YBAs) to residents of the United States.”

The lawsuit alleges that “FTX yield-bearing accounts were unregistered securities that were unlawfully sold in the United States.” It has been said that at least $1 billion in client funds are missing, and Edwin Garrison, the investor who brought the suit, claims that the promoters of FTX were involved in a conspiracy to defraud investors, violating Florida laws that prohibit illicit business practices and require securities to be registered. But according to Reuters, it is still an “open question” on whether U.S. securities laws apply to interest-bearing accounts like those offered by the Bahamas-based FTX.

Government Oversight

Many crypto market tycoons preferred basing their operations in the Bahamas on account of their ‘favorable regulatory environment’. But in the face of this case, the Securities Commission of The Bahamas has now seized FTX’s digital assets in their unit (which was thought to be a hack by the exchange’s new leadership), revoked their license, and has stated that the islands are not a part of the U.S bankruptcy proceedings.

In the States, SEC Commissioner Gary Gensler is under fire for not catching this massive case of fraud sooner. FTX’s downfall has exposed just how little government oversight is involved in this incredibly volatile space, and this is going to continue the conversation around whether these tokens should be considered (and regulated) as securities similar to stocks and bonds.

(Learn more about the current regulatory landscape here.)

The Impending Legal Landscape

While multiple legal actions are already underway, there is likely to be a tsunami-sized wave of litigation coming for both FTX and the cryptocurrency industry as a whole. This collapse comes alongside a series of conflicts affecting the tech industry at large; stocks are crumbling, venture capital is lacking, and mass layoffs have hit close to 800 tech companies as interest rates rise on account of pandemic growth. This fallout will also cause investors to think twice about putting their money into unstable assets like crypto tokens, potentially hindering the overall growth and stability of the industry. Over the past few years, crypto’s market penetration has exploded as it is now the most invested in sector of the fintech market with the industry’s biggest banks betting on this new payment system. But will this investment be enough to keep them afloat amid the unstable environment?

Several law firms are looking into bringing claims on behalf of FTT investors, and future investor suits are projected to allege claims over securities registration, consumer protection violations, and market manipulation. Securities class action suits are predicted to be some of the most prominent as FTX investors are seeking to recoup losses on everything from months of paychecks to their life savings that lived on the FTX platform.

2021’s crypto J.P. Morgan is now looking more like 2008’s Bernie Madoff in the face of this fallout, and those involved in the space need to start preparing now for potential civil and criminal suits. Engaging with experts early in the litigation process can help law firms understand the complexities of the crypto industry, and assist in determining the full picture of what happened at FTX and why. And with the legal risks in the digital assets market increasing at such a fast pace, experts can help companies and executives avoid criminal and civil litigation exposure before it’s too late.

If your company needs help preparing for these challenges, reach out to WIT for the best experts to advise you on your strategy. Our expert teams were created to address what we expect to be the key areas of litigation in emerging financial technologies, digital assets, and cryptocurrencies and exchanges.

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