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FTX users have a leg up on other crypto bankruptcy victims—on paper

Leon Neal—Getty Images

FTX filed for bankruptcy last Friday, capping off an incredibly volatile week that saw the fourth-largest global cryptocurrency exchange collapse in stunning fashion.

Approximately 130 FTX-affiliated companies, including the U.S. arm, were included in the Chapter 11 bankruptcy filing in Delaware while the FTX Bahamas arm filed for Chapter 15 bankruptcy in the U.S. Southern District of New York.

A Chapter 15 format allows foreign representatives of FTX—in this case, the liquidators appointed by the Bahamas Supreme Court—to seek recognition in the U.S. for a pending foreign bankruptcy or liquidation proceeding.

But while FTX opted to file for Chapter 11—as dozens of companies do each year—what comes next for the firm, and its investors and customers,  is far from clear. Although Celsius and Voyager, two failed U.S.-based crypto firms, filed for bankruptcy proceedings earlier this year, the courts have made only limited progress and provided little clarity around customers’ legal rights in cases of crypto-related insolvency.

Typically in corporate bankruptcy, creditors with secured claims—mortgages, liens, etc.—or those with preferential status (employees with unpaid wages or the IRS demanding back taxes, for example) are first in line to recoup their losses, followed by investors, and then customers and those with unsecured claims.

In the cases of Celsius and Voyager, it has been argued that an exchange’s funds, including customer assets, could be seized by an administrator to cover its debts. In that scenario, customers would likely become unsecured creditors, meaning they’re at the back of the line of those who want to be reimbursed.

FTX isn't like other crypto bankruptcies for users

FTX customers, unlike like previous failed crypto firms, may be in a better position. That's because under the FTX user agreement, account holders retain right and title to their property—those assets never became FTX’s property, says Miles Fuller, head of government solutions at TaxBit, a cryptocurrency tax and accounting software company.

Specifically, the FTX US terms of service user agreement, last updated Sept. 16, 2022, reads: “Title to cryptocurrency represented in your FTX.US Account shall at all times remain with you and shall not transfer to FTX.US.”

Further, section 8.2.6 of FTX.com’s user agreement says: “You control the Digital Assets held in your Account. None of the Digital Assets in your Account are the property of, or shall or may be loaned to, FTX Trading; FTX Trading does not represent or treat Digital Assets in User’s Accounts as belonging to FTX Trading.”

It’s worth noting that customers who opted into a yield-earning program were not under those same protections and so those assets could be considered FTX property in the bankruptcy proceedings, according to Coindesk.

“That is definitely a distinction from what we saw earlier this year with things like Celsius and Voyager. Those platforms had accounts [agreements] that clearly said the opposite,” Fuller says. “So that is a different thing—and even the bankruptcy lawyer community is discussing right now about how that's going to play out.”

If it is determined that the assets FTX had on deposit on the platforms are still customer assets, that means they're not the property of the exchange, and they would not become part of the bankruptcy—they would have to be returned, Fuller says.

Terms of service may only be the starting point

If those terms of service are upheld, that could be a big deal for customers. Instead of getting pennies on the dollar for the value of their crypto and other assets as unsecured creditors, in what's shaping up to be a long and drawn-out proceeding, users could get everything returned before FTX’s creditors get to divide what’s left of the exchange’s assets. That’s, of course, assuming FTX still has customer funds after hackers stole nearly $400 million from the firm on Friday night. Reuters has also reported that at least $1 billion in FTX customer funds are missing.

Again, this is all assuming that the terms of service are upheld. FTX’s creditors in the bankruptcy proceedings will likely argue against customers’ retaining their rights. Further complicating the issue is that FTX seems to have violated its own terms of service agreement when it allegedly transferred customer funds from FTX to Alameda Research.

If the terms were already violated and customer funds commingled, it could make it easier to argue that customers don’t have any rights to those funds and classify FTX users as general unsecured creditors.

If that all seems murky, that’s because it is. In fact, on Wednesday, Sens. Elizabeth Warren (D-Mass.) and Dick Durbin (D-Ill.) sent a letter to founder Sam Bankman-Fried and John Jay Ray III, the newly appointed CEO of FTX, demanding answers. “One thing is clear: The public is owed a complete and transparent accounting of the business practices and financial activities leading up to and following FTX’s collapse and the loss of billions of dollars of customer funds,” the lawmakers wrote.

There’s a lot for the bankruptcy judge to sort out, but one thing is for certain: It’s not going to be a quick resolution. “It's going to take a little while for this to sort out and see what comes up,” Fuller says.

This story was originally featured on Fortune.com

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