The crypto ecosystem is facing a full-blown financial crisis reminiscent of 2008. Numerous crypto companies have failed in the past few months, triggered in part by the collapse in cryptocurrency prices this year following their highs in 2021. These collapses have created a slow-moving contagion – again reminiscent of the 2008 financial crisis.

The collapse of the Terra/Luna “algorithmic stablecoin” ecosystem wiped out billions (if not tens of billions) of notional value – including the Terra “stablecoin” that was pitched as a non-volatile store of value. Several large crypto funds were reported to have sizable investments in that ecosystem, which destabilized their finances. However, because this was a purely crypto-based system and not a traditional company, its collapse was somewhat opaque: there were no insolvency proceedings, and numerous market players have denied exposure.

The next domino to fall was Celsius announcing on June 12, 2022, that it would freeze all customer accounts “[d]ue to extreme market conditions” – which, of course, was actually because it was insolvent. Others followed: crypto hedge fund 3 Arrows Capital (“3AC”) went radio silent and plunged into insolvency proceedings in the British Virgin Islands, leading to Voyager Digital (which had lent a vast amount of its assets to 3AC, filing for bankruptcy in the Southern District of New York on July 6, 2022.

Numerous other crypto companies have been bailed out – largely led by crypto exchange FTX. For example, FTX offered a liquidity facility to BlockFi of up to $400 million, with a purchase option to purchase all equity in BlockFi for a sliding scale price of up to $240 million.

However, in the past week, FTX itself has collapsed with a rumored massive hole in its customer accounts. FTX had one operating subsidiary placed into an involuntary liquidation in the Bahamas on Nov. 10, 2022, and FTX quickly (and without the usual preparation such a filing entails) placed the remainder of its entities into Chapter 11 in Delaware on Nov. 11, 2022 (along with certain other entitles associated with its CEO, including FTX US and Alameda Research). Hard data is scarce, but reports – sourced to presentations made by FTX’s CEO, Sam Bankman-Fried – indicate that FTX “loaned” $8 billion of FTX customer assets to his affiliated hedge fund, Alameda Research. More accurately, it appears the funds were simply stolen.

Brown Rudnick is closely following the FTX situation, and will put out separate updates on that situation as facts come in. That said, based on initial reports, we have several thoughts, which we have presented here in our white paper.

Read the full white paper here.

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