Lost money in crypto bankruptcies? Here’s what to do

The crypto space has been devastated by several platforms and exchanges going bust in recent months. For their part, investors have become frustrated with how to recoup their losses, unlock their frozen assets or how to avoid getting caught up in legalities.

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Let’s take a look at how so many people lost their crypto holdings and what means they have to get their money back.

The collapse of crypto

The now infamous FTX platform, of course, filed – along with its more than 130 subsidiaries – for Chapter 11 on November 14, 2022.

Contagion from the FTX fallout followed, with fellow crypto platform BlockFi also filing for bankruptcy on November 28, saying this “follows the shocking events surrounding FTX and associated corporate entities and the difficult but necessary decision we made as a result of pausing most the activities on our platforms.”

In January, another FTX bit the dust, when the Securities and Exchange Commission (SEC) charged Gemini and Genesis with “the unregistered offering and sale of securities to retail investors through the Gemini Earn asset encryption program.”

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“Through this unregistered offering, Genesis and Gemini raised billions of dollars worth of crypto assets from hundreds of thousands of investors. Investigations into other securities violations and other entities and individuals linked to the alleged misconduct are ongoing,” the SEC said in a Jan. 12 statement.

All of this, of course, came on the heels of the previous busts of crypto-lending platforms Voyager Digital and Celsius, which promised eye-watering returns to their clients — that is, until they both filed for bankruptcy in July 2022 due to their exposure to the now-notorious Three Arrows Capital, which itself went bankrupt after the implosion of Terra LUNA and its TerraUSD stablecoin.

Who owns the crypto?

Now millions of investors are left looking for answers – and their money.

“Whether the customers of these bankrupt crypto entities will have access to crypto and cash held on these respective platforms is typically determined solely by the governing terms and conditions,” said Richard Mico, Banxa’s U.S. managing director and head of legal affairs. “The fundamental question in reviewing the terms and conditions is: Who owns the assets held by these platforms?”

In general, if the assets held by the platforms are owned by the customers, they will not be the property of the platforms in bankruptcy, Mico explained. Customers should get their assets back much faster.

“If the assets are ‘owned’ by the platforms,” ​​Mico said, “then the customers will typically be nothing more than unsecured creditors — ranking behind secured and other priority creditors in the related bankruptcy process.”

This often means that after the secured and other priority creditors have been paid, there are not enough assets for all unsecured creditors to be paid in full.

“Unsecured creditors usually rank equally among each other — so the remaining assets are split evenly between them, meaning they often only receive cents on the dollar,” Mico said, noting that the type of bankruptcy chosen by a particular platform can also dictate its length the time it takes for the customer to receive a refund.

Mico added, “All of these issues are currently being carefully considered and investigated in the Celsius, BlockFi, and FTX collapses.”

How Bankruptcies Affect Your Taxes

Another factor to keep in mind is that the bankruptcy process tends to be very long. While a platform is in bankruptcy proceedings, you cannot take a loss on your tax. While you wait, TurboTax recommends that the best thing to do is gather documents related to your crypto account.

Once the platform’s bankruptcy is settled and the assets are deemed worthless, “you can offset the loss of crypto based on what you paid for it against your gains and offset any additional losses against ordinary income such as wages up to $3,000,” says TurboTax. “Any additional losses over $3,000 can be carried forward to the next year.”

All in all, there are few options for recovering losses in such cases. Aaron Kaplan, founder and co-CEO of Prometheum, noted that recovery from FTX and other debacles is likely to be quite limited as the costs of bankruptcy will reduce the final payments that will be available to customer creditors of these failed institutions.

However, Kaplan added that investors who have other capital gains should consult their tax advisors about writing off the losses from these failed institutions against such capital gains.

“Many class actions have been initiated against various participants and/or aiders and abettors in the failed institutions’ activities,” he said. “These class actions are likely to provide a small return to injured investors.”

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