Key takeaways

  • On Monday, crypto lender BlockFi filed for Chapter 11 bankruptcy protections in the aftermath of FTX’s implosion
  • Ironically, BlockFi lists FTX as its #2 creditor after a substantial bailout earlier this year
  • The domino-ing bankruptcies reveal the early dangers of crypto lending platforms’ interconnectedness

On Monday, crypto lender BlockFi announced that it officially filed for Chapter 11 bankruptcy as the FTX fallout spreads. It’s only the latest casualty in an uncertain industry besieged by an ongoing “crypto winter” off 2021’s unprecedented highs. And, if reports from Gemini and Genesis are any indication, the ripple will travel further yet.

What is BlockFi?

BlockFi is a New Jersey-based crypto lending platform founded in 2017 by fintech executive and crypto entrepreneur Zac Prince. The company considers itself a “bridge” between cryptocurrencies and traditional financial products.

Since 2017, the high-profile firm has raked in hundreds of millions in investments from big-name investors and hedge funds. As crypto values surged in 2021, BlockFi claimed to manage over $15 billion in assets. (A valuation that’s certainly taken a hit amid the crypto winter.)

But BlockFi’s bread-and-butter clientele were small retail investors. The crypto lender offered near-instant, crypto-backed loans with no credit checks. Investors could also deposit crypto funds in high-interest deposit accounts.

BlockFi’s first entanglement with FTX

Unfortunately, it was exactly this financial model that put BlockFi on the path to trouble.

Since BlockFi’s products are valued based on crypto values, its business is dependent on healthy crypto prices. So, when the crypto market plunged in 2022, BlockFi’s revenues went with it…and the financial troubles began.

To stave off the worst of the crypto winter, BlockFi opened a $400 million credit line with crypto lender FTX this summer. The firm borrowed $275 million upfront to tide it over a rough patch as investors panicked and prices plunged. As part of the deal, FTX retained the option to buy out BlockFi for $240 million – an option that never materialized.

At the time, the credit line was viewed as a safety net thrown by one of the most dominant and stable crypto firms in the industry. BlockFi CEO Zac Prince hailed the opportunity, noting that it offered “access to capital that further bolsters our balance sheet.”

Still, the credit line was just a stopgap: BlockFi also laid off about 20% of its workforce, reduced executive compensation and slowed new hiring. For a while, it appeared the crypto lender was in the clear.

Until it wasn’t.

BlockFi’s bankruptcy filing

On Monday, BlockFi officially filed for Chapter 11 protection in New Jersey, the first bankruptcy officially linked to FTX’s November 11 bankruptcy filing.

BlockFi’s CEO blamed the firm’s “substantial” exposure to FTX, alongside a tumultuous crypto market, for its liquidity crisis. Thanks to its $275 million credit line entanglement, when FTX toppled amid accusations of gross corporate and financial mismanagement, BlockFi began to struggle, too.

In the days after the FTX collapse, BlockFi shuttered deposit withdrawals and trading activity amid ongoing stability concerns. The firm has also asked customers to refrain from making more deposits for the time being.

100,000 creditors – including the U.S. government

According to BlockFi’s bankruptcy filing, the crypto lender owes money to upwards of 100,000 creditors. Unfortunately, some of these debts are substantial.

BlockFi’s first-largest creditor is Ankura Trust, a company that, ironically, manages loans for distressed companies. BlockFi owes Ankura around $729 million.

FTX holding West Realm Shires is BlockFi’s second-largest creditor, owed the $275 million from BlockFi’s line of credit usage.

BlockFi also lists the U.S. Securities and Exchange Commission $30 million. The balance stems from a $100 million settlement this past February connected to charges that BlockFi failed to properly register itself and a crypto-backed loan product. The SEC also found that BlockFi made false and misleading statements regarding crypto-related risk levels.

BlockFi’s bankruptcy plans so far

BlockFi is expected to appear in bankruptcy court Tuesday to start hammering out early plans. The firm has purportedly hired counsel to aid the process.

In a filing, BlockFi expressed intent to seek authority to honor certain client withdrawal requests. The goal, according to Mark Renzi, one of BlockFi’s proposed financial advisors, is for BlockFi clients to “ultimately recover a substantial portion of their investments.”

BlockFi also requested authority to continue paying employees and take measures to continue day-to-day operations as the restructuring process proceeds.

Of course, whether any of that will actually happen remains to be seen.

In Monday’s paperwork, BlockFi claimed around $257 million in cash on hand to support the bankruptcy proceedings. It listed its assets and liabilities between $1 billion and $10 billion each.

Going forward, BlockFi hopes to use the Chapter 11 restructuring process to reduce expenses considerably. Proposals include cutting staff, recovering obligations owed to the company, and paying certain customers a mix of cryptocurrency, cash and new equity shares. The plan also includes an option to sell the company.

However, BlockFi warned that recovering assets and carrying out plans could take longer due to its financial entanglement with FTX. FTX is also in the throes of bankruptcy proceedings. If early reports are any indication, that situation could drag on for months, or even years.

Still, BlockFi has expressed positivity for its predicament. In a blog post, BlockFi said that it hopes its Chapter 11 case will help the company stabilize and maximize value for stakeholders. “Acting in the best interest of our clients is our top priority and continues to guide our path forward,” the post reads.

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A quick word on FTX

We’ve mentioned FTX quite a few times, so let’s take a quick refresher.

FTX is a crypto lender and exchange founded by Sam Bankman-Fried. Prior to its November 11 bankruptcy filing, FTX was seen as a “blue chip” crypto lender of sorts. The responsible “bank,” if you will, bailed out and acquired a rapidly-growing list of crypto firms.

The first substantial signs of trouble appeared in early November. A CoinDesk report revealed that Alameda Research, another Bankman-Fried firm, held a $5 billion position in FTX’s native token. The investment wasn’t based in a fiat currency or external cryptocurrency, raising concerns about the two firms’ solvency and leverage.

The news sparked a run on the firm’s crypto coffers, totaling $6 billion in withdrawals in three days. Rival firm Binance also abandoned a potential rescue deal, cementing FTX’s financial woes.

To handle the fallout, bankruptcy and liquidation expert John J. Ray III, who led Enron through its liquidation proceedings, has taken on the mantle as FTX’s CEO.

After just two weeks on the job, he’s identified “unprecedented” levels of corporate dysfunction and financial mismanagement. In his 40 years of experience, he says, he’s never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”

Legal experts contend that it could take years to trace and recover FTX’s assets, given the lack of appropriate paperwork and FTX’s complex entanglements. FTX is estimated to have as many as one million creditors.

Other crypto lenders under strain

BlockFi isn’t the first crypto company to go bankrupt this year – but it is the first casualty that can trace its filing directly to FTX’s bankruptcy.

Soon after FTX’s collapse, the lending arm of crypto brokerage Genesis also showed weakness. The firm suspended redemptions and new loan originations after spiking withdrawal requests exceeded its liquidity levels.

Gemini, a Genesis partner, soon followed suit, warning that some redemptions from an interest-bearing program would be delayed.

Earlier this summer, BlockFi competitors Voyager Digital and Celsius
CEL
Network both filed for bankruptcy amid extreme market conditions leading to substantial losses at both companies. At the time, Bitcoin
BTC
alone fell over 20% in a single week.

Ironically, BlockFi had noted that it, too, suffered losses totaling $80 million and a 20% staff reduction in the period – but its FTX loan kept it afloat.

Until, of course, FTX itself collapsed.

What this means for investors

The enmeshed downfalls of FTX and BlockFi reveal a growing concern in the crypto industry: a shaky foundation resting on volatile digital currencies. Beyond that, though, is the revelation that crypto companies may be growing so intertwined that a single stumble can set off a domino reaction of balance sheet woes and currencies declines.

Think of crypto lenders and exchanges like FTX and BlockFi as the de facto “banks” of the crypto world. Many of these companies boomed during the pandemic’s crypto surge, attracting billionaires, hedge funds, “crypto bros,” and retail investors alike.

But because the crypto industry sits in its fledgling stages, regulations are patchy and inconsistent, when they exist at all. Crypto-based lenders and banks often don’t have to follow the same regulations or consumer protections common at traditional banks.

So, when one crypto lender with inadequate liquidity levels faces a crisis, they find themselves woefully exposed. Consider FTX: when this supposedly stable crypto giant went down, it took down a whopping 130 affiliates with it. The damage has only begun to spread into separate – yet linked – companies from there.

And so far, it appears that customers are the ones shouldering the brunt of the losses.

This reality has compounded the risks inherent to crypto for many investors. Crypto winter aside, the exchanges and lenders that are supposed to provide stability in a volatile industry have proven that they themselves are risks.

As an investor, that puts you in a precarious position. Not only do you have to worry about the value of your portfolio, but it’s likely that the industry will face a regulatory reckoning in the coming months.

Grab an AI pick-me-up when BlockFi bankruptcy drags you down

As an investor, cryptocurrencies remain a risky proposition at best. While history has shown there’s money to be made in the space, more recent events have found that those profits can come at a tremendous level of risk.

That’s why we advise approaching crypto very cautiously, and with the expectation that you may lose every dime you invest.

However, some investors aren’t turned off crypto entirely – after all, it’s a whole new world of promise. For those investors, Q.ai’s Crypto Kit offers AI-backed digital currency exposure via regulated public trusts. No, it doesn’t eliminate volatility entirely – but it does offer a little extra protection in an explosive industry.

But if you want to minimize or avoid cryptocurrency, Q.ai has plenty of other Kits to consider, too. Tech lovers satiate their appetite for risk and reward (plus a little crypto) with our Emerging Tech Kit. And our other Foundation Kits offer a healthy mix of core holdings to get you started – with little to no crypto involved.

It’s hedge fund investing without the hedge fund, all backed by the power of AI.

Download Q.ai today for access to AI-powered investment strategies.

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