Crypto Bankruptcy Markets Are Thriving After FTX’s Collapse

Before Aleksandar found crypto, he made the equivalent of $500 a month working as a computer repair technician and, later, at the cash-transfer company MoneyGram. He earned slightly below the national average in North Macedonia, where he lives. But then crypto made him rich.

In 2019, when he was 20 years old, Aleksandar—who asked that his name be changed so he could discuss his private financial affairs—took out a $5,000 loan to invest in cryptocurrencies. It was a risk, but he’d watched the market falling and felt he could snag a bargain. As it happened, he ended up timing the dip almost perfectly. Two years later, after crypto had gone on another hot streak, Aleksandar was sitting on more than $105,000. In North Macedonia, he says, that’s almost like winning the lottery.

But that’s where his luck ended. Aleksandar was trading on FTX. When the crypto exchange, whose founder is facing 13 criminal charges, went bankrupt in November, Aleksandar’s savings were locked inside. Short of money, he had to sell his car and take a loan from family members to get by. He found he couldn’t sleep without a drink. But the worst part, he says, was how “stupid” he felt for being made a sucker. “I was in a really dark place. The first few months were literal hell.”

Aleksandar is one of hundreds of thousands of people around the world unable to access their funds after turmoil in the crypto industry took down some of its leading players. Along with FTX, crypto lenders Celsius, Voyager Digital, BlockFi, and Genesis Global Capital, as well as hedge fund Three Arrows Capital (3AC), all collapsed, leaving investors—from small traders to financial institutions—at the mercy of bankruptcy proceedings. 

These collapses, and the difficult situations that investors have found themselves in, have helped drive the growth of digital marketplaces for trading bankruptcy claims, which give speculators willing to wait out the legal cases a chance at large returns and cut-price exposure to crypto. Some, like Open Exchange, which is headed by the former founders of bankrupt hedge fund 3AC, are even trying to tokenize these claims, turning crypto failures into new tokens that holders can either sell off or post as collateral. 

Some claim holders accuse the marketplaces and buyers of taking advantage of distressed sellers. But with their money locked away, potentially for years, others are having to take the hard decision to sell their claims now for a fraction of their paper value.

Aleksandar chose to sell directly to investment fund Cherokee Acquisition, which also operates Claims Market, one of the biggest public bankruptcy claim marketplaces. He received fewer than 20 cents on the dollar for his FTX claim, he explains, but at least it allowed him to “be done with it and move on.” 

The market for bankruptcy claims isn’t new; it’s been going on at least since the 1980s. When somebody buys a bankruptcy claim, they are buying an IOU—a right to a portion of the money returned to creditors at the end of a bankruptcy case. The length of bankruptcy proceedings varies drastically, depending on the extent of the mess, but some (as with crypto exchange Mt. Gox) can take as long as a decade to close.

The motivations on each side of claim sales are different, but complementary. The seller either needs immediate cash to meet bills, wants to write down their losses for tax purposes, or believes they can earn a greater return by investing the money elsewhere. The buyer, meanwhile, is wagering that the value eventually returned to creditors will exceed the amount they paid for the claims.

Claim sales have typically happened behind closed doors, taking place between financial institutions. But over the past few years, public marketplaces for bankruptcy claims, such as Xclaim and Claims Market, have emerged, bringing a degree of transparency to what was an opaque market and allowing almost anyone with a claim to list it. 

“We’re giving people the power to make a choice they otherwise wouldn’t have,” Matthew Sedigh, founder of Xclaim, says.

The growth of these marketplaces has been catalyzed in no small part by bankruptcies in the crypto sector. Between $20 billion and $30 billion is currently locked up in crypto bankruptcies, according to estimates from Open Exchange and Xclaim.

In late 2022, Xclaim pivoted to focus exclusively on crypto bankruptcies. Since then, the marketplace, which by January had listed more than $200 million in total claims, has attracted more users and drawn in greater revenue than in the two previous years combined, Sedigh says.

Buying claims in crypto bankruptcies is seen as a way to invest in crypto at a discount. Although each creditor’s claim is valued in dollars on the date of the bankruptcy filing, not denominated in crypto, the balance sheets of these firms are made up largely of crypto assets. Therefore, if crypto were to appreciate in price, claim holders would receive a greater return. In the case of Mt. Gox, the judge even decided that claim holders should share fully in the rise in crypto prices, meaning they are set to make a return of over 100 percent on their claims when redistribution begins on October 31.

However, purchasing claims is not for the faint of heart, says Thomas Braziel, founder of 507 Capital, an investment company that specializes in distressed debt, which holds a large position in the Mt. Gox bankruptcy and others. Not only do creditors sometimes misrepresent the value of their claims, intentionally or otherwise—some people “fib around the edges,” says Braziel—but some claims turn out to be entirely fraudulent.

In other instances, a buyer might discover that a claim is subject to clawbacks, because the original holder made undisclosed withdrawals shortly before the bankruptcy, eating into any profit they might hope to make. In bankruptcies, funds withdrawn in the 90 days before a filing are later pulled back into the estate, to avoid a scenario in which a minority of creditors are rewarded for being faster on the trigger.

For these reasons, says Muhammed Yesilhark, chief investment officer at asset management company NOIA Capital, thorough due diligence is vital. “If we can’t find three or four people in the industry to vouch for the seller, we don’t get involved. Anything that is remotely smelly, we don’t touch,” he says. “It’s not like buying toilet paper on Amazon.”

As competition for claims in the FTX bankruptcy began to heat up, NOIA settled on a strategy that would help the firm to minimize risk and outcompete other buyers: It would pay under the going rate for claims but promise the original claim holders 20 percent of the upside in the event of a payout.

Some victims of crypto collapses have reacted badly to offers to buy their bankruptcy claims. Michael, a Celsius creditor from New York, who asked to be identified by first name alone in order to discuss private financial matters, says he was hoping to sell his $450,000 claim “ASAP,” in order to reinvest in the crypto market. But he balked at the 20 cents on the dollar he was offered by Cherokee, which he describes as “vulture thieves.”

Bradley Max, director at Cherokee, is bemused by the “demonization” of buyers and marketplace operators. He says companies like his own provide important liquidity, giving those who wish to sell the option to do so. And in any case, buyers are far from guaranteed to make a profit.

“The market is efficient; the competition to buy these claims should result in a fair market price, based on the current facts and circumstances of each case,” Max says. “Like any investing, sometimes investors get it right, sometimes they don’t. It can happen that claims buyers end up paying way more than is ever recovered.”

But Michael’s attitude is not uncommon in the Telegram channels where creditors congregate to discuss the progress of bankruptcies. When Aleksandar asked about selling his FTX claim, he received angry messages, he says, telling him not to “come in here with that doomer attitude.” In a separate encounter, in September, a Cherokee representative trying to drum up business in a Celsius group chat was told by an admin that his messages were “tacky” and made him sound like a “used car salesman.”

New entrants to the bankruptcy claims marketplace business have attracted a similar level of contempt, like Open Exchange, the firm developing a way to turn bankruptcy claims into easily tradable tokens. The fact that the project is headed up by Davies and Zhu, the 3AC founders, and executives from crypto exchange CoinFLEX, which filed for restructuring in August, is an irony lost on nobody.

The plan first came to light on January 16, when CoinDesk got hold of a pitch deck. Not only was the new marketplace provisionally branded as “GTX”—simply “because G comes after F”—but it would also allow customers to trade claims in 3AC. In a tweet, Nic Carter, partner at venture capital firm Castle Island Ventures, questioned whether it was ethical for Davies and Zhu to “skim fees” on claims in their own company’s bankruptcy.

However, Leslie Lamb, CEO at Open Exchange, says this is an unfair characterization. “Our first priority is to give people the option of being able to trade their claim,” she says. “We want to find as many paths to help creditors recover value, across as many bankruptcy estates, as possible.”

Whether bankruptcy claims can be safely tokenized is another question. Because each claim is unique, collecting them together and turning them into a set of homogenous tokens is difficult. But Lamb insists the system is viable and will help creditors “benefit from more liquidity and fairer pricing,” regardless of the size of their claim. Open Exchange is preparing to launch its claims trading service in the spring and says thousands of claim holders have already signed up.

While bankruptcy marketplaces pitch themselves as a place for small investors to cash out and move on, the reality is that smaller creditors tend to receive a raw deal on pricing—or at least, large claims command a premium. Because of the cost of vetting a claim and administering a sale, the majority of buyers are looking for a small number of large claims, not a large number of small ones.

While a number of institutional investors, like hedge fund Galois Capital, have been forced by circumstance into sales, others are as reluctant to sell as the creditors on Telegram. Kyle Samani, managing partner at Multicoin Capital, an investment firm with tens of millions of dollars tied up in FTX, says the company has never once considered selling its claim. “The kinds of people buying claims are obviously aiming to make very high returns,” says Samani. “So why would we sell to them?”

There is an extent to which regular people are never going to come out of a bankruptcy in good shape, whether they choose to sell their claim or not. The harsh truth, says Braziel, is that the game is rigged against anyone lacking the resources or expertise to fight their corner.

“In bankruptcies, the squeaky wheel gets the grease,” he says. “The guys with millions of dollars at stake can hire expensive bankruptcy lawyers to argue for them. The people who really get hurt are the small [creditors], who just get fucking walked over.”

The decision to sell is not an easy one for people caught up in FTX and other crypto bankruptcies, whose desire to close out a painful chapter rubs up against a determination to avoid being taken advantage of twice over. But at the very least, suggests Aleksandar, selling allows creditors to take back a measure of agency, even if it comes at a financial cost.

Aleksandar is well aware of the inequities of the bankruptcy food chain—and it made his decision to sell an easier one. “The big fish,” he says, “are gonna eat first.”