Companies that received financing from the bankrupt crypto exchange have sought to block FTX from making claims on assets.
In April this year Bridge Network, a Barbados-based crypto startup, received $500,000 in financing from FTX Ventures, the corporate venture arm of the now defunct cryptocurrency exchange. The parties entered a so-called simple agreement for future tokens (SAFT), a contract that arranges for the eventual transfer of digital tokens from the crypto startup to the investor.
These agreements are a common way of financing crypto startups. The contracts give the investor the right to receive future tokens issued by the portfolio company. These digital assets are often more liquid than traditional venture equity because the investor can sell the tokens when the startup has created a market for the tokens, whereas it can take a decade or more before investors can sell preferred stock in a startup when (or if) it exits.
But FTX will not have access to the Bridge Network tokens. Following its collapse, the startup made the decision to prevent FTX from transferring those tokens out of its crypto wallet, a type of account for digital assets.
“Technically, those tokens are dead and off the market,” Kimberly Adams, co-founder of Bridge Network, told GCV.
FTX also does not have the right to recall its $500,000 investment under the terms of the financing agreement, according to Adams.
Bridge Network’s move is just one way that crypto startups are seeking to protect their assets following the November bankruptcy of FTX, which was valued at $32bn shortly before its collapse.
The failure has created turmoil in the crypto industry with investors pulling billions of dollars’ worth of digital assets off exchanges over concerns of further bankruptcies. The arrest of FTX CEO Sam Bankman-Fried this week on charges of fraud will further tarnish the downtrodden reputation of the sector.
Crypto startups report a difficult market for raising financing as fear of FTX contagion grips the market. “It is almost embarrassing to say you work in crypto right now,” says Adams. Her company, which is building a platform to move tokens between blockchains, is seeking to raise $75m in a series A round. She is leaving enough time in this fundraising round to do thorough due diligence of investors.
“It is important for projects to raise when they don’t need to,” she says. “We have enough runway, but we want to start the fundraising process now because we want to see who the credible VCs are, who are betting on the long-term vision of the market and are not looking for a quick buck.”
Number of FTX startup ventures in the hundreds
FTX was a prolific investor in crypto startups. The company had several venture portfolios, including FTX Ventures and Alameda Ventures. The number of investments is around 500 and have a combined value of more than $5.4bn, according to a corporate spreadsheet published by the Financial Times.
It is unclear how the bankruptcy trustee will treat these assets. The matter is complicated by a dispute between the US and the Bahamas over where the assets are held. FTX filed for bankruptcy in the US, but the financial regulator in the Bahamas, where FTX was based, seized all the company’s digital assets for safekeeping, proclaiming in a press release that it had the authority to do so as the regulator.
While it may take years for the assets to be unwound in bankruptcy, buyers for the crypto startup portfolios are likely to come forward. It is possible a single buyer will come along and purchase the entire portfolio of companies, says Neil Foster, a partner at law firm Brown Rudnick. He predicts the sector will see a wave of mergers and acquisitions at steep discounts. “You can be consolidated, or you can be a consolidator, at low values for the next six months,” he says.
Bankruptcy is a great place for investors to go shopping, says Noah Schottenstein, a senior attorney at law firm DLA Piper. “If you are interested in picking up crypto investments, this is a great time to express interest. There is a lot of value in buying out of bankruptcy because you can purchase assets free and clear of any liabilities under the US bankruptcy code.”
It is unclear what will happen to the co-investors in startups that FTX invested in. If FTX is a lead investor, this could complicate future funding rounds. “Let’s say FTX invested in 50% of a series A round. They would control the amendment to take in new money. If the assets are at FTX Ventures and locked up, these companies may be unable to raise new capital or do complex workarounds because FTX is not voting anymore,” says Mark Radcliffe, partner at DLA Piper.
Startup financing agreements often contain a compulsory transfer of shares that is triggered during an insolvency. This clause gives the board of the portfolio company the ability to serve notice that there was a transfer of those shares to other investors. But each financing agreement will be different and not all contracts will contain the same wording on what happens to the shares in case the investor goes bankrupt.
“Each one of those investment documents will need to be reviewed to see what happens in the circumstances of an insolvency. Normally, that leads to the transfer of those shares or the cancellation of those shares at nominal value,” says Foster.
Startup crypto financings hard to come by
Startups are understandably concerned about their ability to expand and receive financings. “The FTX situation added uncertainty to the crypto space in the short term, both in terms of the capacity for it to grow and thrive, and questions about how it will be regulated moving forward,” says Charlie Graham, founder and CEO of Hawku, a software platform for trading non-fungible tokens, in an email.
Hawku received $4m in financing from Alameda Research Ventures, according to Pitchbook. Graham says his company did not keep any of its funds in the accounts of FTX and Alameda Research, a trading firm also set up by Bankman-Fried. “Indirectly, it has affected us and all cryptocurrency companies by adding more fear, uncertainty and doubt into the nascent space, and causing people to pause before entering the space,” says Graham.
Another startup that received financing from Alameda is Solrise Finance, a decentralised fund management protocol. CEO Vidor Gencel says Alameda could not ask for a return of its $500,000 investment in the company because it is not in the time period in which it could do that. It lost a small amount of funds on the FTX exchange but Gencel is more concerned about the reputational damage on the crypto sector.
“People lost a lot of money, not because they invested recklessly, but because of a player who gained the trust of millions. That trust is now gone, and suspicion has been created in all other systems that operated on a smaller scale than FTX did,” says Gencel in an email.
In the long term, industry observers say the FTX fallout will lead to a more regulated and, consequently, more stable crypto industry. Already policymakers have moved to step up oversight in response to criticisms that companies such as FTX were able to grow rapidly and globally with little oversight. International regulator Financial Stability Board said it will create rules to regulate the cryptocurrency industry early next year.
Adams at Bridge Network welcomes more regulation of centralised crypto infrastructure such as exchanges. But she balks at the idea that decentralised finance, which underpins the crypto industry, should be regulated, as this part of the sector has held up well compared with the turmoil on the crypto exchanges.
Ultimately, the sector will be stronger as the FTX fallout weeds out players that are in it for the short term, she says. “The future will be more decentralised, and it will be for players who have a good grasp on doing this for the right reasons as opposed to those who do it for a quick buck.”