Crypto lending platform BlockFi filed for Chapter 11 bankruptcy on Monday, just a few weeks after once-major crypto exchange FTX did the same. While BlockFi has been struggling to stay afloat for months now (and was even potentially going to be acquired by FTX), this latest filing signals that the bankruptcy contagion may run deeper than what the crypto industry sees at the surface.
“It is another example that the crypto winter is not over, and with the FTX debacle, it’s going to persist longer than previously expected,” Ric Edelman, founder of Digital Assets Council of Financial Professionals (DACFP) and author of “The Truth About Crypto,” said to TechCrunch.
“There is clearly a large amount of self-dealing and excessive leverage in the system, and until most of that is washed out through business failures, M&A and regulatory actions, the crypto winter will persist.” Ric Edelman, founder of Digital Assets Council of Financial Professionals
With BlockFi now in the midst of bankruptcy proceedings alongside FTX, Celsius, Three Arrows Capital and Voyager, others in the crypto space are wondering if and when the next crypto firm will find itself on the chopping block.
“The level of intercompany investment within the blockchain and crypto community is unusually high, so the level of contagion is likely to be much higher than what we saw within the traditional financial community in 2008-2009,” Sam Dibble, partner at Baker Botts, said to TechCrunch.
“Unfortunately, the complexity of these intercompany investments is not fully known at this point and so the companies themselves probably don’t know how badly they will be impacted,” Dibble added. “My guess is that the entire industry will be impacted somewhat by the FTX and BlockFi bankruptcies, with a significant number of severe casualties.”
FTX had become a central figure in the industry and its dealings were wide, so its collapse has broad implications, Aaron Jacob, head of accounting solutions at TaxBit, said to TechCrunch. “Unfortunately, there will be businesses that are hurt by the FTX bankruptcy not because they were mismanaged, but because they had an overreliance on FTX and their trust was misplaced in a bad actor.”
Generally speaking, there’s an expectation that more companies will fold — some because of contagion from FTX, others merely because they can’t survive the crypto winter, Edelman said. “We saw a similar effect in 2018.”
Last week, crypto financial services firm Genesis told TechCrunch it has no plans to file bankruptcy imminently, but other news outlets reported a potential for bankruptcy if it couldn’t raise fresh capital quickly.
Genesis faced a liquidity crisis after FTX collapsed, which “created unprecedented market turmoil, resulting in abnormal withdrawal requests which have exceeded our current liquidity,” Genesis said in a series of tweets on November 16. The firm decided to “temporarily suspend redemptions and new loan originations in the lending business.” But the suspension has not been lifted and no new news has been announced since then.
It’s also worth mentioning that BlockFi wasn’t considered a rinky-dink crypto startup. In March 2021, BlockFi closed a $350 million Series D funding round that valued the company at $3 billion. Bain Capital Ventures, partners of DST Global, Pomp Investments and Tiger Global co-led the round with participation from a number of other firms.
Earlier this year, it attracted negative attention from the U.S. Securities and Exchange Commission, which charged BlockFi for failing to register its retail crypto lending product and violating the registration provisions of the Investment Company Act of 1940, according to a press release in February. To settle the charges, BlockFi agreed to pay a $50 million penalty to the SEC and an additional $50 million in fines to 32 U.S. states. According to a filing on Monday, BlockFi still owes the SEC $30 million.
“Their bankruptcy filing is an incredibly unfortunate development — not only for their customers, but also for the industry,” Jacob said. “It illustrates the ongoing reverberations impacting the industry following the FTX collapse.
“The current market environment has exposed critical weaknesses and risk factors that certain companies in the industry face,” Jacob added. “These include being overly leveraged, under capitalized, or having dependencies, especially when those dependencies are on bad actors — like FTX — and the contagion effect that has.”
Since there are many intercompany investments in the crypto space, if some companies fail — and proprietary or exchange-specific token values fall to zero or decline significantly, as with FTX’s FTT cryptocurrency — that will spread through the industry “like a shockwave causing liquidity crises, loss of confidence and insolvency,” Dibble said. “This may happen quickly, as FTX experienced, or may take a bit longer since the pace of the bankruptcy process for FTX and BlockFi is slower than this industry is accustomed to.”
It’s also worth noting that many crypto companies were formed in the past four years after the end of the last crypto winter, Edelman said.
“It’s easy to start and grow a business when you have lots of VC [investment] and you’re enjoying the wave of sharply rising crypto prices,” Edelman added. “But when those prices collapse, and it becomes clear that the business was growing not because of smart leadership or a sound business model, its revenues are quickly overcome by expenses and bankruptcy is an inevitable result.”
So how deep is the rot beneath it all? Only time will tell, both Jacob and Dibble said.
“No one knows for sure, but it’s extensive,” Edelman said. “There is clearly a large amount of self-dealing and excessive leverage in the system, and until most of that is washed out through business failures, M&A and regulatory actions, the crypto winter will persist.”
While the ultimate timeline is uncertain, Edelman thinks it will likely take another six to nine months before there are signs of “emergence” from this situation.
Similar to previous crypto market cycles and the economy more broadly, the best companies will survive and can even emerge stronger, Jacob said.
“When market events like this happen, it exposes and even exaggerates risks that businesses have. It also pressure tests the strength of a company’s balance sheet,” Jacob said. “Those companies that aren’t able to pass the test will suffer.”