The Cryptocurrency Industry and Its Distressed Cycles

Welcome to the 119th Pari Passu Newsletter, 

In early 2025, the market has been discussing the possibility of a strategic Bitcoin reserve that would store cryptocurrency to use during a future crisis or supply disruption [1]. In 2024 alone, the price of Bitcoin has risen by 140%, exceeding returns from stocks and gold [2]. What does this mean about the future role of cryptocurrency in our society? 

Today, we will dive into what drives the value of cryptocurrency, the business model of crypto exchanges, the relationship between different market players, and the structural problems that triggered a series of crypto bankruptcies since 2022. With a foundation of distress in crypto, the next post will dive deeper into the infamous FTX Bankruptcy that changed the digital market forever.   

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Introduction to Crypto

Since trading emerged in the 1600s, it has led to various forms of trading, such as stocks, commodities, and foreign exchanges. In 2009, the first cryptocurrency, Bitcoin, was invented. Cryptocurrency trading follows the same basic rules of trading - buy low and sell high - but with digital assets. Digital assets can be anything from a photo to cryptocurrency but must satisfy a few conditions: they must generate value for the owner, can transfer ownership and the value behind it, and can be stored and found [3].  

Fundamentally, crypto traders come in with a very different investment strategy from stock investors. Although stock investing has a wide range of strategies, a stock investor owns shares of an established company. Their focus is on the company’s earnings and growth potential. A crypto trader, on the other hand, has different expectations. While crypto prices tend to be more volatile, investors are rewarded with quick, generous returns. Over the past ten years, the average annualized return of the S&P 500 was ~13.2% compared to Bitcoin’s ~85%. Other traders treat crypto as a good hedge against inflation due to its fixed supply and long-term store of value. 

Very simply, a crypto trader generates profit from a trade in the following steps: 

1.  Choose a cryptocurrency exchange

2.  Add funds to a crypto exchange account in traditional currency or transfer cryptocurrency balance from an existing cryptocurrency wallet 

3.  Select a cryptocurrency to trade based on technical or fundamental analysis (or both)

   1. Technical analysis: make short-term trading decisions based on past price movements and market data to identify future price movements 

   2. Fundamental analysis: evaluate the cryptocurrency’s intrinsic value based on the cryptocurrency’s technology (scalability, security, innovation), economics (supply,  distribution), market size, regulatory environment, the developer’s qualifications

4. In crypto trading, exchanges happen in pairs. Investors can either choose to exchange a cryptocurrency for another cryptocurrency or a cryptocurrency for a ‘fiat currency,’ referring to a government-issued currency like the USD. 

   The concept is very similar to foreign exchange. For example, if Bitcoin is exchanged for US Dollars, it would be represented as a ticker pair BTC/USD. If BTC/USD = 30,000, it means one Bitcoin is worth $30,000 USD. By selling 0.5 BTC at a rate of $30,000 per BTC, the trade would record 0.5* $30,000 = $15,000 USD on the trader’s exchange and bank account. The Bitcoin’s exchange value to USD changes every second due to its volatility. Inherently, crypto trading is difficult because a trader has to compare the value of two different currencies. 

5. Based on the investor’s risk appetite, they might sell out their position to make profits when prices are strong. If they want to hedge against crypto’s volatility, they might reinvest these proceeds into asset classes with a negative correlation to crypto, such as gold. On the other hand, some might continuously trade crypto even if prices skyrocket, referred to as momentum investing [4].

Before getting to the bigger market events, it’s important to understand why crypto trading is a volatile asset class, the unique supply and demand dynamics, and some key metrics. 

Key Drivers of Cryptocurrency Prices: What is ‘Value’? 

Here’s where things can get a bit fuzzy with a touch of philosophy.  Just like any market, crypto prices are subject to the forces of supply and demand, macroeconomic forces, and geopolitical stability. When the COVID-19 pandemic was declared in 2020, crypto tokens recorded the largest historical drop by 40%. In late 2021, when inflation started to rise and the market became concerned about a potential rate hike, Bitcoin decreased by 19%. The sell-off continued in January 2022, with Bitcoin falling 17% and Ethereum plummeting 26%. When the market becomes unstable, investors turn towards safer assets like US Treasuries. With higher rates, bond yields would result in high returns. On the other hand, when rates are low, the yield from safe assets is low. Investors would be open to riskier assets with higher returns, like stocks and crypto. Between 2018-2022, the correlation between crypto and stock returns was under 0.3. However, this correlation can sometimes increase above 0.5 when investors expect positive macro tailwinds, such as when the Fed announced a 50 bps rate cut in 2024 [5].

In summary, crypto and stocks are driven by fundamentally different factors. Crypto valuation is driven more by market confidence in the future adoption of crypto, liquidity, supply and demand, and regulations. On the other hand, stock valuation is determined more by increased earnings, interest rates, and monetary policies.   

What’s interesting about Bitcoin specifically is that Bitcoin’s supply was designed to be capped at 21mm BTC. From the year 2140, no new Bitcoins will be issued.  When Bitcoin’s creator Satoshi Nakamoto invented Bitcoin in 2009, he established a process called “reserve halving”: every four years, the rate of issuing new Bitcoin decreases by half. In Bitcoin, new coins are created only from a special mechanism called mining. Bitcoin miners are specialized computers or individuals that collect transactions from the Bitcoin network and bundle them in a ‘block.’ A block is just a unit of data that stores transaction details. As a reward, they earn a certain number of bitcoins per block, but this ratio has been halving every four years. In 2009, it was 50 BTC per block. In 2012 it was 25 BTC per block, and will decrease to 0 BTC per block by 2140. This means that Bitcoin is a very scarce asset with a fixed schedule to reduce supply. Theoretically, halving would increase the investment value of Bitcoin because lower supply would increase scarcity and demand. After the halving, demand would increase as more investors would be drawn to participate in the price appreciation. Historically, every halving cycle has driven up prices, but the rate has flattened out recently. It is unclear whether the market has priced in the value from future halvings, so other factors, such as liquidity, would be more crucial to understanding future price movements [6]. 

Let’s turn from external to internal forces. Swinging between fear and greed is a natural emotional rollercoaster for a crypto investor. The graph below shows a typical Bitcoin market cycle where the accumulation phase attracts investors with an optimistic view and buys up Bitcoin at a low price. Then, in the growth phase, the price steadily rises as more investors want to capture rising prices until it peaks (halving cycles have occurred here). In the ‘bubble’ phase, the Fear and Greed Index shows the highest greed as the price exceeds the historical highs. Selling volume builds up slowly as more buyers push up prices. At last, the bubble crashes. Repeating the previous cycles where Bitcoin prices came down by 80%, the latest cycle has also seen an all-time high of $69k in November 2021 to $15k in November 2022.

Unsurprisingly, there is no consensus on the value of crypto. It has also been evolving constantly. 

Everyone can have a view of the ‘true’ value of crypto. For some, it can be worth less than a penny. In fact, Bitcoin is not backed by any cash flows like an actual business. A value investor might echo Buffett’s comment that “Cryptocurrencies basically have no value and they don't produce anything. In terms of value: zero.” But for others, it might hold infinite value. For example, initially, many expected Bitcoin to be a widely adopted currency, but this is unclear, given how volatile and deflationary it is. Now, many appreciate crypto as a ‘store of value’ that is not meant to be used now but stored for long-term purposes. The statement “valuation is more of an art rather than science” could not be more fitting for crypto as an asset class. 

So what gets investors confident in the value of crypto? 

When a user sees the price of crypto rise, they increase their trading activity, expecting that there will be another buyer at a higher price. When they see the price of crypto fall, they will decrease their trading activity. However, this is only the first layer that drives investor psychology. Improved security, regulations, and the increased adoption of crypto is also what moves the market. Currently, Bitcoin is accepted as a payment for 15 thousand companies around the world, including blue-chip companies such as PayPal and Microsoft. Increased endorsements from major institutions could boost the confidence of mainstream investors, increasing market liquidity and credibility [9].  

One of the most interesting aspects of distress in the crypto world is how closely interconnected all the players are. Let’s say a company’s supplier goes into distress. Depending on how much exposure and role the supplier plays in the value chain, the company itself may or may not be severely affected. In crypto, the ripple effect of distress is much more prominent. Compared to the stock market, there are fewer market participants, so any sell-off would lead to a greater drop in prices. Crypto traders also take on higher risk by taking on higher leverage than stock market participants, as further elaborated below. Furthermore, crypto market participants are structurally designed to be dependent on each other. How does each player depend on one another? Which party has the upper hand in the relationship? A look into the center of the value chain would be a good starting point.  

The Business Model of Crypto Exchanges [10]

A crypto exchange, just like a stock exchange, is the market infrastructure where buyers and sellers trade cryptocurrency. The main streams of revenue come from the following: 

1. Transaction Fees: a crypto exchange generates revenue by taking a percentage of every trade as transaction fees. In a simple example, there are two parties in a trade, and the exchange charges 0.10% of the dollar amount for each trade. If a trade is worth $10k, the exchange will make  $10k*0.001*2= $20 (multiplied by two because both parties pay a transaction fee). 

   However, this fee is not fixed. It’s similar to how a business discounts customers who have purchased more than the regular customer. To reward traders who bring in more volume with lower transaction fees, many exchanges have a volume-based pricing system. The lower fees will incentivize these large traders to trade more often, creating a positive loop that benefits both the traders and the exchange to increase revenue. This is why crypto exchanges prioritize boosting liquidity, as it directly contributes to their profits. 

   Transaction fees look different across crypto exchanges, attracting different types of traders. 

   Higher transaction fees mean an exchange has stronger pricing power. For example, Coinbase has the highest transaction fees, between 0.4 and 0.6%, while competitors mostly sit in the 0.1-0.2% range. However, Coinbase has been able to use these fees to invest in higher-quality customer service, security, and compliance as a publicly traded company. 

2. Deposit and Withdrawal Fees: when the user funds the crypto exchange account with fiat currency, deposit fees can occur, and when the user removes cryptocurrency from their account, withdrawal fees occur. Many exchanges set deposit fees near zero while withdrawal fees are charged as a fraction of each coin. For example, withdrawing Bitcoin costs an average  0.05% fee, which equates to $5 for every $10,000 of deposit. 

3. Subscription Services: While most exchanges don’t, Coinbase is a unique model that has a monthly subscription service catered towards more experienced traders at $29.99/month for zero trading fees and priority access to customer support. By growing its subscription revenue, Coinbase has been trying to hedge against the large exposure from volatile Bitcoin volumes.

It may seem like crypto exchanges are just like stock market exchanges that simply act as a platform. This is not entirely true. Some crypto exchanges have built a brand by developing digital tokens and giving fee discounts to traders who use their native tokens. On top of this, exchanges can retain customers by offering better customer services, an easier user experience, and a wide variety of currencies. 

However, the risk associated with this business model is that revenue is concentrated around the most liquid tokens even if the exchange offers a variety of currencies. For example, Coinbase drives more than 50% of the trading volume of Bitcoin and Ethereum, which have shown positive correlation across market cycles, so it is hard to hedge against broader market movements. 

Different Types of Crypto Exchanges [11]

Among the five hundred available crypto exchanges, each exchange has unique features. Some focus on simple transactions, while others provide more advanced services such as derivatives trading, NFTs, and pool mining where miners work together and share mining rewards. More broadly, users have the option to choose between a centralized exchange (CEX) or a decentralized exchange (DEX), each creating their own ecosystem called centralized finance (CeFi) and decentralized finance (DeFi). 

Some popular CEXs include Binance, OKX, Bybit, and Coinbase. While these names would be relatively unfamiliar to most people given DEXs’ smaller historical market share at 5% of total crypto trading volume, the most popular DEXs are Orca for Solana, Pancakeswap for BSC, Uniswap for Ethereum.

CEXs are run by a single entity that manages buy and sell orders in a single location. Due to faster trading speeds, higher-quality customer service, and a stronger user authentication process, many crypto traders have historically preferred CEX over DTX. Most importantly, CEXs have higher trading volumes because they service a wider range of clients and offer lower costs. This liquidity has allowed traders to quickly buy and sell assets at stable prices even during volatile market conditions. 

A company is considered distressed if they have insufficient assets to meet its liabilities. Similarly, a crypto exchange that halts customer withdrawals (liabilities) because they do not have enough cash or cryptocurrency (assets) would be treated as a default. Default rates for CEXs exchanges have started to rise up to 20% in 2022 for different reasons than historically. In the 2010s, the main reason was primarily exposure to security breaches and hacking [11]. More recently, the main reasons have been commercial misjudgement and poor risk management. For example, Celsius has failed because they were over-exposed to currencies, Brittex due to regulatory uncertainty, and Voyager because of defaulting counterparties. The FTX bankruptcy, which we will cover next week, is a clear example of this. 

On DEXs, however, traders can directly trade with each other without a middle-man. This allows them to have direct ownership and better security protection over their money.  To facilitate trades without a bank, broker, or centralized exchanges, DEXs rely on “smart contracts.” Smart contracts are digital contracts stored on a blockchain that match buyers and sellers, hold funds securely during a trade, and automatically complete transactions when predetermined conditions are met. If you are a trader, you can trust the information on the exchange because the transaction records are shared across all parties. On top of this, you can save transaction fees as there is no middleman charging you. While the platform still lags behind CEX’s level of trading volume, which is still in the early stages, DeFi is a rapidly growing area within crypto. 

Further Breaking Down the Ecosystem 

In a market where counterparties rely on each other to generate profits, it is crucial to understand what their role and value propositions are. Broadly speaking, the players can be categorized either into action takers or infrastructures that serve the market participants that rely on each other: 

• Miners: individuals or large businesses that use highly specialized computers to validate and add new ‘blocks’ to the blockchain. They get paid through block rewards from their blockchain network, which incentivizes them to maintain the integrity and security of a cryptocurrency network. For example, preventing users from attempting to spend the same coins twice. The block they receive decreases after each halving event, but the existing block stays the same. 

• Investors: retail investors have traditionally dominated the crypto market, attracted by high, speedy returns that can exceed 100% in bull cycles. Some investors in foreign countries also use crypto to hedge against inflation and the falling value of their currency.

However, institutional investors have increasingly been drawn to crypto, seeing progress in scalability and regulations. In January 2024, the SEC approved Bitcoin-funded ETFs, lowering the cost of crypto exposure. Hedge funds tend to use crypto for higher returns, opportunities to capture price inefficiencies, and portfolio diversification, while pension funds have been allocating a small portion of their portfolios to crypto. Fortune 500 companies such as MicroStrategy have been buying Bitcoin to store it on their balance sheet as a hedge against inflation, betting on its long-term value. 

Some crypto traders use margin trading, a risky yet lucrative strategy by borrowing leveraged funds. This allows the margin trader to trade with more capital than they own. Depending on the exchange, a trader can borrow up to 100x their balance. For example, if a trader wants to invest $10k in Bitcoin with 10x, they would need to have 10,000/10 = $1000 stored as collateral in their account. Assuming the price increases by 20% to $12k, the trader’s profit will be $12,000-10,000 = $2000 vs. the original $1200-1000= $200 they would have made without the use of leverage. However, leverage works the other way around when prices drop. If the price is down 20%, the trader’s position is down by $2000, and the balance turns negative to $1000-2000= -$1000. If the trader cannot increase their funds with more collateral, they are forced to liquidate because the fund's lender will not pay for the trader’s loss. A crypto exchange automatically triggers a liquidation when the user’s balance dips below a threshold called maintenance margin, which ranges between 2.5%-10% of the balance. 

However, margin trading is not only used by retail investors but also hedge funds. Usually, crypto hedge funds diversify exposure across different tokens and adjust risk in their portfolios to prevent margin calls. However, in 2022, many hedge funds faced a series of margin calls after the collapse of a specific token, as further explained below. As crypto prices plummeted, the value of the borrower’s collateral was also wiped out so that hedge funds could not pay back their investors[13]. 

• Lending Platform: can be centralized like traditional banks, where the platform serves as a middleman to facilitate lending and borrowing. The major centralized platforms are BlockFi, Celsius, and Voyager. It could be decentralized, operating on blockchain technology, where lenders and borrowers directly interact with each other. For decentralized platforms, automatic processes called ‘smart contracts’ determine loan issuance, repayment, and interest rate automatically based on market supply and demand. They generate revenue from deposits, withdrawals, and service fees from managing loans. They also absorb the spread between the interest rate the borrower pays and the rate lenders earn interest on.

• Lenders [14] [15]: some investors don’t have the risk tolerance to do margin trading themselves, so some platforms offer a feature called ‘spot margin trading.’ Instead of directly trading crypto, users can lend money in cryptocurrency or fiat currency to other users on the platform and earn interest income and principal.  Unlike traditional loans, loan agreements do not need any or only a few intermediaries like banks, so borrowers can pay lower fees and lenders can boost their returns. Most loans are backed by collateral in the form of a specific cryptocurrency deposited by the borrower. Exchanges usually require the collateral to cover at least 100% of the loan. Compared to traditional loans, crypto loans have higher interest rates, around 5%-13%. These rates compensate lenders for volatile crypto prices that determine the collateral value and the lack of credit checks required by borrowers.

  They can be structured as either fixed or floating rates. However, there is no maturity date for crypto loans. In a way, these open term loans are similar to a revolving credit facility since the borrower can repay the loan anytime. However, this also means lenders can demand repayment anytime. Given the volatility of crypto asset prices, most platforms control the risk of default by allowing borrowers to access only up to a certain percentage of the collateral, called loan-to-value (LTV). Usually, an LTV of 70% (for example a $7k loan is backed by $10k of Bitcoin) would be considered high, demanding a higher interest rate to account for higher risk. If the value of the collateral drops below the LTV, the exchanges will automatically liquidate the loans. 

• Traditional Banks: traditional banks can allow crypto investors to hold their fiat currencies in accounts linked to their crypto-related activities. They can also issue collateralized crypto loans back by fiat currencies. Some banks offer products such as crypto ETFs. 

Until now, we’ve covered what determines crypto valuation, the business model of crypto exchanges, and structural elements driving distress in the market. Now, we will break down specific events leading up to the series of crypto restructurings since 2022. 

The Ripple Effect of the 2022 Crypto Winter 

A list of bankruptcies across all parts of the crypto value chain – from crypto hedge funds to exchanges – has dominated news headlines since 2022. Rather than viewing these events separately, it is necessary to trace back to the sources of distress by analyzing their relationships. Within the span of May to June November, the greatest number of crypto-related defaults occurred in history. 

Mayhem in May – The Collapse of the TerraUSD Stablecoin [16]

The series of crypto defaults in 2022 started with the collapse of the TerraUSD (UST) token in May 2022, a type of stablecoin, which lead to a drop in $60bn of UST’s market cap. Its downfall sparked a broader distrust towards cryptocurrency and wiped out $400bn of the $2 trillion total crypto market cap. Terra was the third largest cryptocurrency payment network that created a stablecoin called TerraUSD (UST) that could be converted into another cryptocurrency called LUNA. [17]

As the name suggests, stablecoins are a type of cryptocurrency that maintains a stable value relative to another asset. Many cryptocurrencies, like Bitcoin, have been too volatile to be used in everyday payments because they are not backed by real assets. Invented in 2014, stablecoins have attempted to reduce this volatility by using less volatile assets as backing. They are ‘pegged’ to typically a country’s currency, commodities like gold, other crypto assets, or even US government bonds, short-term corporate debt, and bank deposits. 

In an ideal scenario, the stablecoin is backed by $1 and maintains the value. If the stablecoin’s value decreases to $0.95, the investor will generate a loss of $0.05 when they sell it on the exchange.  However, investors are allowed to request the issuer of the stablecoin (companies like Terra) to redeem each stablecoin for $1. This comes from the trust that the issuer has enough currency in a reserve (similar to a back-up drive) to meet all requests of redemption. 

Plot twist – the stablecoins were not stable. UST’s stablecoin value decreased to $0.96 but was not backed by a full dollar, meaning there was no collateral when investors demanded it. To put this into context, the value of LUNA dropped from $87 to $0.0005 and UST dropped from $1 to $0.2 in only eight days [18].  

The main issue was that LUNA was an algorithmic stablecoin where a software algorithm tries to maintain supply and demand. However, the algorithm was too slow to respond to panic sell-offs. Most importantly, the reserve did not perform its role. Theoretically, when a user redeems $1 worth of stablecoin, the reserve would have enough assets to give back $1. With no asset backing like a fiat currency, LUNA’s value came from the market’s confidence in the token’s demand, much like what drives crypto’s value. Until the collapse, LUNA’s valuation had increased not because investors could pinpoint a specific metric but simply because investors saw other investors buying the token. When investors learned that this system was no longer sustainable, they began selling their UST, hoping there would be some remaining value to LUNA. Unsurprisingly, no one wanted to buy LUNA, and the price plummeted to zero rapidly. Marketed as a safer cryptocurrency, TerraUSD was ultimately a fraud that promised investors enough collateral when, in fact, there was none.

In summary, without proper regulations, transparency in the stablecoin system, and intrinsic value supporting a token, investors began questioning the sustainability of the stablecoin market, resulting in the Terra-LUNA crash. 

Key Parties Affected: Three Arrows Capital, Alamesk, Voyager, Tether, Celsius and more 

A lot of different parties have been affected for different reasons. Let’s look at each relationship and its greater implications for the crypto ecosystem. For the sake of understanding the ripple effect of the Terra-LUNA collapse, it is helpful to visualize these events in the concept of layers. 

The most important layer that brings together all of the separate defaults together is the decline in crypto prices. From November 2021 to November 2022, Bitcoin prices declined by 77.5% from $69k to $15k, reflecting and fueling the market’s distrust in crypto that sparked a massive withdrawal from customers across all crypto-related businesses. 

The TerraUSD stablecoin collapse raised the need for more asset-backed USD stablecoins like Tether, the largest stablecoin related to LUNA. Unlike TerraUSD, Tether was backed by collateral such as cash and short-term debt. As investors feared about the quality of the collateral, Tether temporarily lost its 1:1 dollar peg and its price dropped to 95 cents on the dollar. However, this stablecoin continued operating as it improved their collateral transparency, but the market began to demand more stablecoin regulations [19]. 

Prominent Singapore crypto hedge fund Three Arrows Capital (Three AC), managing $10bn AuM, invested at least $200mm into the Terra-LUNA token. Their LUNA holdings worth $462mm in April 2022 plunged to $2700 within a month. The collapse of LUNA triggered a broader sell-off in the crypto market, wiping out another $858mm of Three AC’s digital token holdings. When the token crashed and investors began demanding Three AC to return their funds back, the firm was forced to file for Chapter 15 as they did not have enough liquidity. Under Chapter 15, they had to liquidate the entire company. 

Here is where the domino effect came in. Three AC had to pay back a total of $3.5bn to 27 companies: $2.4bn to crypto lender Genesis, $270mm to crypto exchange Blockchain.com, $670mm to digital asset brokerage Voyager Digital, $129mm to BlockFi, $6mm to crypto derivatives platform BitMEX, and $75mm to crypto lender Celsius. While these loans were not repaid at the time and positioned the companies to file bankruptcies, as the bankruptcies progressed, Three AC reached settlements with the debtors and boosted the creditor recoveries.   

Characteristics of Distress in the Crypto World 

But before moving on to crypto bankruptcies,  let’s summarize what makes distress in the crypto world so unique – a repetitive cycle heavily dependent on market psychology. First, a borrower expects crypto prices to rise, so they decide to take on more leverage. Higher demand pushes prices upwards. A market event increases the perceived risk of the asset class. Prices drop rapidly, and the loans liquidate as the collateral goes below the maintenance margin. Confidence in the asset class gradually recovers from expectations for wider adoption, drawing more traders to take on leverage, and so the cycle repeats. 

Complicating things even more, lenders’ ownership over crypto collateral can be extremely murky. For example, when a lender decides to re-lend the same collateral that backs a loan to another borrower, the same collateral base belongs to different borrowers. Who exactly has full ownership over the collateral is a key consideration as we dive deeper into the crypto restructurings. 

Specifically, here are a few takeaways from how hedge funds spread distress in crypto to other market players:  

• The market did not investigate enough into public records. As a crypto hedge fund, Three AC’s positions were public on the blockchain rather than disclosed in an offshore bank account. Experts could have pointed out concerning signs of their funds earlier. 

• Margin trading in crypto is especially risky. Three AC and Alamesk used a risky strategy of levering up their investments with funds borrowed from the exchange and other traders. 

This meant that Three AC had to liquidate its crypto holdings and repay outstanding loans within a very short period of time. Another reminder that leverage boosts both gains and losses. 

• The value of collateral is very volatile in crypto. Lenders would have to carefully evaluate the margin trader’s collateral quality and be ready for sharp declines in crypto prices in market downturns. Creditors have pointed out that Three AC misled lenders about the extent of their exposure to excess leverage on long crypto positions, and most were undercollaterized.  

• The interconnectedness of the system. Three AC borrowed from different crypto lenders, including retail holders, across the industry and used the extra capital to invest in other developing crypto projects. Crypto usually comes with very little customer protection, leaving retail investors especially unsure what they would recover. 

FTX’s Bailout and the Summer of Bankruptcies 

Between May and June 2022, the crypto market cap decreased by 48%. One by one, companies began to file for bankruptcy. In the chaos, SBF and FTX began bailing out other crypto firms. In June 2022, FTX extended a $485mn loan to crypto broker Voyager Digital. Days later, FTX provided lending provider BlockFi with a $200mn loan. SBF and FTX were even called the “JPMorgan of Crypto.”   

In one interview in September 2022, SBF commented that “it was important for people to be able to operate in the [crypto] ecosystem without being terrified that unknown unknowns were going to blow them up somehow” [20]. Little did the market know that SBF and FTX would be the biggest source of terror in the coming weeks – more to be covered in next week’s post. 

Let’s do a quick case study of Genesis Global, a bankruptcy of a crypto lender that showcases the hurdles to a crypto bankruptcy with an unconventional outcome. While the bankruptcy did not occur during the summer of 2022, the main causes and implications of distress were similar to the other crypto bankruptcies [21] [22] [23] [24]. 

As the largest crypto lender, Genesis could not recover the $176mm loan to Alameda Capital and a $2.4bn loan to crypto hedge fund Three Arrows Capital, which both defaulted and filed for bankruptcy after the Terra collapse. The problem was that the collateral behind Alameda’s loans were FTT, a highly illiquid crypto token created by FTX, which became worthless as the market questioned the stability of FTX (more to be explained in next week’s post). Likewise, Three Arrows Capital did not have enough collateral to pay back the loans.

To break this down, since Genesis allowed highly leveraged trading, they were supposed to offer higher collateral to secure all loans to customers. However, there was not enough collateral to back the loans, so what was considered ‘secured’ turned out to be unsecured. Where did all the money go? Instead of securely storing customers’ funds, Genesis actively lent their customers’ money to other borrowers. Then, these other borrowers would lend the money again to other borrowers. When the loan had to be repaid, it turned out that multiple lenders had to share a piece of collateral – crypto tokens that declined in value during the 2022 market crash.

 In total, Genesis had a loss of $1.1bn on its balance sheet. Surely, nobody would want to deposit money if there weren’t enough assets to repay their money. Here’s where the parent company of Genesis called Digital Currency Group (DCG) stepped in and loaned Genesis a promissory note of $1.1bn due in 2032 with an extremely low interest rate of 1%. While this note temporarily solved Genesis’ liquidity issue, they were still vulnerable to external events. After FTX, which owned Alameda, filed for bankruptcy in November 2022, Genesis faced significant withdrawal requests from customers who were worried about Genesis’ exposure to Alameda.

On January 19th, 2023, Genesis Global filed for Chapter 11 bankruptcy. As of the petition date, the debtors owed $5.1bn in liabilities to 100k customers. Their biggest individual claim was $765.9mm owed to Gemini, a crypto exchange. In addition, they owed a total of $32bn to state and financial regulators, including the SEC for not complying with requirements to protect investors. The bankruptcy filing claimed that assets ranged from $1bn-$10bn, which was expected to change throughout the bankruptcy. As of December 2023, halfway through the bankruptcy, the debtor’s assets were valued at $3.3bn. Given that these were mostly digital assets, their assets increased in value along with the rise in crypto prices. Their claims in cryptocurrency were worth $4.75-5.4bn as of December 2023’s crypto market prices. Clearly, there were not enough assets to pay out all creditors. So how did they manage to win creditor support? 

There were two types of customer claims: customers who deposited money as either cryptocurrency or cash. Usually, customer claims in crypto bankruptcies are paid in cash based on the crypto price of the petition date, even if the customer’s claims were in crypto. However, in this case, the debtors paid out cash creditors with cash and crypto creditors with the specific token they held. For example, Bitcoin customers in BTC and Ethereum customers in ETH. Paying using tokens maximized creditor recoveries because the tokens reflected the most recent crypto prices, which more than tripled since the petition date. On the other hand, crypto customers would have missed out on all price appreciation if they were paid in cash. More than 80% of each impaired class voted on the plan of reorganization, exceeding ⅔ in dollar amount and half of the creditors of an impaired class needed to confirm a plan. 

However, Digital Currency Group strongly pushed back, arguing that creditors should be paid back in cash with crypto prices in January 2023. This is because under the plan, DCG converted their promissory note into preferred equity, becoming the debtor’s equity owner. Here was DCG’s logic: the debtors had to pay back 63,858 Bitcoin and 449,210 Ether coins. Using January 2023’s price of $21,084 per BTC, customers would receive 63,858*$21,084= $1.35bn in cash, which DCG believed was sufficient for a full recovery. However, since Bitcoin’s price in May 2024 when the POR was filed rose to $67,000 per BTC, customers would get an additional value of 63,858*(67,000-21,084)= $2.93bn that should be redistributed. Nonetheless, the Judge ruled against DCG. Realistically, the debtors did not have enough cryptocurrency left for DCG, especially with $32bn government claims ranked higher in seniority. Ultimately, with only $4bn of assets, both government claims – besides a few parties that reached litigation settlement – and DCG were left with no recovery.

As a result, a total of $4bn in assets were split up among creditors of different types of cryptocurrencies and creditors who held claims in fiat currency. There are two ways to look at the crypto recoveries. First is the number of coins returned. The debtors simply did not have enough coins to return, and as the price of the coin increased, they could only return fewer coins than creditors deposited. For example, a creditor is supposed to receive 10 Bitcoins when the price was $20k. Their claim is $200k. However, the price of Bitcoin rose to $50k, so they would only be paid with $200k/$50k=4 tokens, resulting in a 4/10 = 40% recovery. In August 2024, when the debtors emerged from bankruptcy, the recovery rate for Bitcoin creditors was 51.28%, 65.87% for Ether creditors, 29.58% for Solana creditors, and US Dollar and stablecoin creditors by 100%. While these recoveries might seem low, the second way to look at the recoveries is by comparing the crypto value on the distribution vs. petition date: 166% up for BTH and 153% up for ETH. With the prior example, even though the creditor got 4 tokens, the price the coin rose even more to $70k, so the total value of tokens is 4*$70k=$280k – higher than the $200k of original value. With additional cash and assets recovered after exiting the bankruptcy,  recent recovery rates in January 2025 have also increased to 59.1% for Bitcoin, 74.1% for Ether, and 36.9% for Solana. Going back to our hypothetical example, the debtors get $100k more cash from litigation proceeds and buy back $100k/$50k=2 more tokens to return to creditors, increasing incremental recovery by 20% to 6/10=60% (recoveries were calculated with fixed prices on the initial distribution date in August 2024). More widely used tokens like Bitcoin and Ether achieved higher recoveries as they were more liquid and market prices recovered more quickly. For the creditors who deposited cryptocurrency but their claims were considered to be paid in cash they were fully paid out in cash with a recovery rate of 100%. 

During the bankruptcy, the debtor also avoided lengthy litigation and exited bankruptcy more quickly by settling claims. The debtors and FTX both had claims against each other, but the massive $4bn of FTX claims against the debtors were settled to only $175mm. In exchange, the debtors dropped their $176mm claims against FTX. Overall, this settlement clearly helped the debtors to boost creditor recoveries. Similarly, Three AC had a $1bn claim against the debtors that was reduced to $33mm. However, creditor recoveries could have been higher since the debtors had a $1.2bn claim against Three AC that may have been paid back if successfully litigated. To compensate creditors for this early settlement, the plan also allowed for additional recovery through a litigation fund.

Through Genesis’ bankruptcy, we can see how many crypto lenders had gone bankrupt: a customer made deposits, the crypto lender made loans with these customer deposits, the loans were backed by poor collateral, the depositor panicked and demanded their money back, but the money wasn’t there. 

Characteristics of Crypto Bankruptcies

In hindsight, some of these events would have made little logical sense. How did an entire market lose a market cap decline by 72.5% from $2.9 trillion in November 2021 to $798bn at the end of 2022 [27]?  How did FTX – once valued at $32bn – collapse so abruptly? Most importantly, what do these crypto bankruptcies have in common?

• Unpredictable Valuation: Given that creditor recoveries would be dependent on the value of highly volatile digital assets, the final creditor payout could look different based on the exit timing. 

• Intercompany Loans: The complex intercompany loans between the subsidiaries can create conflicts between creditors on how to determine the priority of repayment. Furthermore, it can make the debtor look healthier than in reality as internal transfer funds are not real cash. Finally, the ownership over the intercompany loan can be widely disputed. 

• Fragmented Creditor Base: Given individual creditors represent most of the creditor base, the debtor must consider how to treat claims across various jurisdictions backed by collateral of different types of cryptocurrency. 

• Illiquidity of Assets: Many crypto exchanges and companies had a portfolio of venture investments that were monetizable. However, it was unclear how the market would value such investments since investors had turned away from funding new projects since the FTX collapse. 

It’s easy to describe the ripple effect of crypto bankruptcies on paper by listing out affected firms and individuals. However, the ripple effect has an intangible quality. Perhaps the real effect transcends time and place: no matter how much creditors end up recovering from bankruptcy or how much crypto prices have been restored, the damage has been done and cannot be simply quantified. .

After the series of bankruptcies, crypto has entered a new era. Near the end of 2024, Bitcoin prices recorded an all-time high of $104,293. That is 560% higher than its price in November 2022. Similarly, other cryptocurrency prices have skyrocketed. Once again, we can see how increased adoption of crypto as an asset class drives higher valuation. For example, MicroStrategy, originally software company, has turned into a Bitcoin holding company. Since 2022, it used low-interest debt to buy $42.2bn worth of Bitcoin as a treasury reserve asset to bet on long term price appreciation [28]. While still early to tell how corporations will adopt crypto, more investors have been seeking indirect exposure to the asset class. For example, the SEC approved Bitcoin ETFs in January 2024 where investors can profit from Bitcoin prices without managing the assets. But most importantly, crypto’s value is determined by every member of our society – including you, the reader of this post – whose judgment and decision of whether to invest in crypto directly creates or destroys value. After all, it was all about what you believed in. 

Sources: [1], [2], [3], [4], [5], [6], [7], [8], [9], [10], [11], [12], [13], [14], [15], [16], [17], [18], [19], [20], [21], [22], [23], [24], [25], [26], [27], [28]

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