Oct 26, 2023

Bitcoin (BTC)'s recent rally hasn't seen these levels since last May, just before the crypto industry faced a series of crypto bankruptcies that included FTX, Voyager and Celsius.

Video transcript

Bitcoin's recent rally hasn't seen these levels since last May when the crypto industry was just starting to get pummeled by scandals. Joining me now to discuss the recent string of crypto bankruptcies is Brown Rudnick chair of bankruptcy, Robert Stark and Vanderbilt Law School professor of law and associate denied. Welcome to the show, Robert and welcome back. Thank you so much. It's a pleasure to be here. All right, the two of you co-authored a piece that's published on coin desk that unpacks what's going on in this industry when it comes to bankruptcies. Tell me, uh, tell me about what brought you two together to, to write that and some of the key takeaways you want to start that one. I'll start with that one. So I have known Yashi Dev in the great and brilliant Yi Forever. Um, and her papers on markets generally and crypto specifically, and I happen to have been um, a bankruptcy professional who is in the middle of it all. And we started chatting about what's going on and why things are the way they are and frankly, what can be learned from it and put our heads together and started actually doing a little bit of research, a little bit of writing and really, you know, I think we're coming up with some interesting things to share and we try to share them. What can this industry take away, would you say from the uh flurry of bankruptcies we've seen since the end of last year. It's made it very clear that the cost of not doing regulation is really extremely high. The bankruptcy courts have become the first front line effectively as Bob and I talk about kind of quasi regulators in the mix. So what the bankruptcy courts have had to do is deal with some super important crypto institutions. As you know, Jen Celsius Voyager FX, they have all gone bankrupt mega bankruptcies that have happened in very close succession and the bankruptcy courts are essentially going it alone. They haven't had the support that most other kind of financial institutions in more regulated markets would have. So for example, bankruptcy courts have had to do their own fact finding, produce their own information, determine what kind of rules to apply in this context and how to apply the bankruptcy code to these novels situations. So perhaps the clearest example here is Celsius, where the bankruptcy court had to decide whether average customers were unsecured creditors or whether the crypto that they put into Celsius was in fact their own property. And unfortunately, for the customers, they took the view that legally speaking under the bankruptcy code the customers were unsecured creditors and regulated securities markets. This problem just wouldn't happen. Or commodities markets, this problem just wouldn't happen there. The assets are kept outside of bankruptcy, they're segregated, they're protected. In the case of crypto, we don't have these rules. And so it's really up to the bankruptcy courts to decide the rules of the game in the context of bankruptcy. But this has had a more broad systemic impact um within a larger impact within the crypto market. Generally, when we, when we look at what's going on, is there a comparable industry or comparable time? Have bankruptcy courts had to do this before? And what, what has the outcome been in, in that case if there is an example? So you've been alive longer. So I think you should take this one. I've seen, seen a few cycles. So we've learned a lot from crypto bankruptcy specifically and the answer is no, there's not very good parallels from prior cycles and areas. Let me tell you why um bankruptcy, you have to think about it. We have these big bankruptcy courts and they do impressive bankruptcy cases, very impactful macro economically. But the actual work that they do is actually a very narrow band. They have to work with other forms of government. And any normal financial company that goes into bankruptcy has been sort of set in place by the rules and the regulations that were established by other arms of the government. Before. So in a financial company, a Wall Street company, a fund, something that was dealing with people's money, intermediate value of a certain way with customers and creditors of the like of a financial space. You had the, the SEC, the FTC, the fed other forms of government that were working a long time before really establishing the rules of engagement the way that they were running. And when bankruptcy happens, those administrative and regulatory bodies are still at work. The bankruptcy only really focuses on, am I going to reorganize this company? Am I going to do something with respect to the creditors and the balance sheet? That's its mission it relies upon and works in tandem with the rest of government to try to bring this all about together. Crypto is pretty much the first area, at least during my lifetime through the cycles that I've seen where financial ser uh a series of financial companies that that collapsed all at once. Um Really do not have the other arms of government working in tandem with the bankruptcy court. Um you know, in, in the early two thousands, you had a spate of very large financial frauds. Enron Adelphia companies like that. He South and the rest of the government was still working. Bankruptcy could focus only on what do we do with respect to the assets and the liabilities and it could do its job with the rest of the government doing its part, crypto has not really had that and, and we're seeing it and sort of, it's funny because it's happening at the same time in Silicon Valley Bank and Signature Bank where we're seeing that customers who put their money in with those banks got their money out because FDIC insurance worked or the FD I and civic programs kind of worked in tandem. You do not have that in crypto and that's created this sort of strange, unique and pretty terrible set of circumstances in these cases. And we see, for example, in the Voyager case, when the SEC did try and intervene in that case, right? So, um in those situations, the way in which the government is interceding is through the bankruptcy process. But um the SEC in that case tried to argue that the acquisition by Binance should not go forward. Um but the court decided that the S ECs evidence in that case was not persuasive. So, you know, this is really the bankruptcy court moving the needle forward, even government regulators who are trying to intercede in that space are doing it as interested parties, not really as regulators that you have a right to be there as a matter of course, because we just don't have any regulation proceeding industry. As Bob said, Geisha, can you let us in on maybe some of the conversations you've had here today? What needs to happen to get this regulation to avoid um to avoid these bankruptcies? What, what's the logical next step here. I mean, I think the conversations that we've had today and it's um huge credit to coin desk that you put an event on like this that has, that has brought so many um folks in the regulatory space together to have these conversations. I think what's happening today and what was said today was that the picture is not as bright as we were hoping it would be. In other words, that to have a comprehensive legislative proposal have a big regulatory agenda in place before the next election. That doesn't look like it's something that is realistic at this point in time. But that's not to say that very specific provisions cannot be enacted. As Bob pointed out, there are some clear vulnerabilities that customers are facing. Customers are being, you know, I don't want to use this word but they are being screwed over, right? They are putting their money in. They don't know what their legal rights are. If they get stuck in bankruptcy, they can end up as unsecured creditors for people who are looking to trust an industry, for people who are looking to keep their savings safe. That is extremely unfortunate state of affairs that the government should be in the business of protecting people from. So we can think about some discreet rule making specific rule making and conversations here speak to the fact that we can try achieve that. For example, rules with respect to asset segregation, keeping crypto away from the balance sheet of the custodian, making sure that the crypto is kept in such a way that it never enters the bankruptcy. So that customers, if they do end up with a custodian that goes into bankruptcy, they get their crypto out straight away and they can be repaid and don't have to worry. Or as ball pointed out, maybe some kind of insurance scheme that crypto custodians and others could contribute into as a way of protecting some of the customer entitlement. So even though the big picture means that we're not going to get some big framework necessarily before the next election. At least these smaller measures seem like they're possible. Robert, one of the biggest trials in crypto is happening right now, Sam Bateman Fried's criminal trial all while FTX is going through its own bankruptcy. How do you think John Jay Ray the third is handling that? How do you feel the bankruptcy is going? Well, it's, it's a tough bankruptcy, just the complexity, the size, the amount of loss and dislocation that's resulting from it. But I, I've known John Ray for quite a while. You probably could not have picked a better person for the job than him. I mean, as honest as the day is long and is going to work as hard as anybody to try to get to an answer. It's an interesting point that in Celsius, you have an examiner's report writing nearly a 700 page report detailing exactly what happened. And that was sort of a presaging of what ultimately happened to Alex Moshinsky s arrest in, in um in FTX. The bankruptcy court said we don't really need to have an examiner. We have John Ray here and John Ray from day one has said we're going to tell you what happened here and obviously, now we have a criminal trial more will come out because of that or through that. Um Nobody really knows, nobody can really predict where it's going in terms of how people are going to recover and what they're going to recover. But you do have AAA sort of a solid hand behind it. Well, if you know John Ray, can you give us a personal anecdote? Why is he the best person for this job? Uh Well, I I met John Ray back when he was the General counsel of fruit of the loom a zillion years ago and that went through its restructuring. He left that job and went to work on Enron. Um If ever you were going to cut your teeth from normal corporate restructuring into massive fraudulent, difficult, you know, markets based problems, it's John and he and he migrated. What is probably one of the hardest transitions anybody can from a professional perspective, from being general counsel to a normal company going through restructuring to Enron. I think he can handle this job and just one thing to add to that Jen, which is that the criminal process is happening. Um The criminal complaints are speaking to questions of fraud that needs evidence on how the money is moved and where it's going and whom that money belongs to. And I think the bankruptcy process has been super helpful in helping the justice department build some of that information. So as John Ray mentioned, when he came into this process, the record keeping at FTX was a complete shambles and that's been corroborated during the trial as well. Um And so I think the work that the bankruptcy court has done, the work that John Ray has done to build up a picture of what was happening with the money through the bankruptcy process. I think ultimately, that's super helpful for the criminal trial as well. You know, outside of the crypto industry, we've seen companies file for bankruptcy, we've seen them survive after that. Do you think that any of the crypto companies that are currently going through bankruptcy will survive? We will make it out on the other side of this? It's such a great question because if you look at, you know, these are seismic important, systemically, really had huge segments of market share in the ecosystem Celsius is the only one that seems to be a trending towards survival in a new form. And hopefully, it does make it through the confirmation process and the regulatory process. That's sort of quickly after the fact the other ones have failed. Um uh We're still in the middle of, of prime and that 1 may come out. But, you know, Blocky and Voyager and the others F TX, they're not surviving. And that's, that, that's a question about how bankruptcy is working with this, in this particular industry. And it's not a great grade so far. So if I could just, just maybe temper some of the pessimism that Bob just brought to the table a little bit. I think there's been some talk and I think Jen, we've spoken about this before. Um that FTX is trying to be brought back. So for example, there are efforts to try and revive the FTX exchange itself. Um and that may be useful for a number of reasons, potentially for giving some value maybe. Um though it's not yet clear to the F TT token, right, that could potentially gain in value or have some greater um uh some greater usefulness should um FTX come back in some form. So I think there is some discussion underway to create a very compliant friendly, super easy to use exchange in the form of an FTX 2.0 where that goes is anybody's guess and it could just end up completely failing, particularly given the regulatory uncertainty that we have at present. But this is one way to try and get some value to some of the assets that underlie FTX as a way to try and bring, bring the exchange back. And just one final thing if I if I could, you know, coming what Bob said, one of the big questions in crypto is how to value these assets as a whole. And that's something the bankruptcy court is doing for the first time and it is doing it on its own. And it's a pretty hard job, Robert you brought up Block five. I know Brown Rudnick represents the official committee of unsecured creditors in block five chapter 11. Can you give us any updates there? Well, the plan was confirmed some weeks back and today was the day that the plan went effective. It's hard to say. Um, but I feel this, I'm gonna say it anyway. Um, we got through that case comparatively, relatively quickly. Um You know, we started our work in the beginning of January. We pretty much had a deal by the spring. Um, that's fast in bankruptcy generally. And in what we're seeing in all of these cases of size, that's really fast. Um, in part, it was a sort of a, a disciplined approach the committee took, we were not going to exhaust every single option and, and see one M and a process after another, try to rebuild it. We, we were just going to try to get you an answer and get it through the bankruptcy as quickly as possible, get people's money back as fast as possible. And I, I'm pretty, I'm pretty proud of what we did Robert Ya. Thanks so much for joining me here and good luck with the rest of the day. We'll see you soon. Thank you so much, Jen for having us. That was Brown Rudnick, Chair of Bankruptcy, Robert Stark and Vanderbilt Law School, Professor of law and Associate Dean Ya Yadav.

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