FTX crypto contagion continues after BlockFi bankruptcy

Fears of contagion in cryptocurrency markets continue to grow after BlockFi filed for bankruptcy on Monday due to the company's financial ties to failed crypto exchange FTX. 

It now says it owes more than 100,000 creditors between $1 billion to $10 billion. Eight of its affiliated firms are in Chapter 11 bankruptcy proceedings.

BlockFi, a lending platform in the crypto space, allowed individuals to use cryptocurrencies as collateral for loans denominated in U.S. dollars. It ultimately peaked at a valuation of roughly $3 billion in early 2021.

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When crypto assets experienced a downturn over the last year, the price drop meant that the value of the collateral was less than the value of many of BlockFi's outstanding loans. That caused it to experience liquidity problems and enter into a loan arrangement with Sam Bankman-Fried's FTX in July as part of an effort to shore up its books. 

Bitcoin, for example, has fallen to the $16,000 level, down more than 71% during the past 12 months.

The agreement included a $400 million credit facility for BlockFi and also gave FTX the option to purchase BlockFi for up to $240 million. FTX had played a similar role for dozens of firms through acquisitions and investments, and the deal gave BlockFi a critical lifeline. BlockFi also made loans to FTX's sister company, a hedge fund known as Alameda Research.

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Once FTX imploded and Bankman-Fried resigned as his former company entered bankruptcy proceedings, BlockFi's ties to FTX worsened its financial situation.

Amid FTX's collapse and descent into bankruptcy, BlockFi "became trapped" and unable to access its credit facility. It was then forced to halt withdrawals from its platform and asked clients to not make deposits to their digital wallets or accounts.

One of those creditors is the federal government. In February, BlockFi agreed to pay the Securities and Exchange Commission (SEC) a total of $100 million in penalties after it failed to register the offers and sales of its retail crypto lending product. The company still owes $30 million to the SEC as it enters bankruptcy proceedings.

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The bankruptcy process is intended to give the company the stability needed to restructure, and BlockFi says it has $256.9 million in cash on hand that can provide enough liquidity to support some of its operations during the restructuring.

It's unclear at this time what impact the collapse of FTX and Alameda Research will have on BlockFi's bankruptcy proceedings and vice versa. BlockFi owes FTX $275 million, while Alameda Research owes BlockFi for the $680 million in loans it received before its implosion, according to bankruptcy filings.

While BlockFi's exposure to FTX dragged it into bankruptcy, it may not have featured similar failures of corporate controls that FTX had.

In BlockFi's bankruptcy filings, the company's financial adviser stated, "To date, I have not found any failure of corporate controls or systems integrity, and I have found BlockFi's financial information to be trustworthy." That statement stands in stark contrast to the situation at FTX, where the company's new CEO noted "pervasive failures" of corporate controls in bankruptcy filings and stated that there was a "complete absence of trustworthy financial information."

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Late Monday, BlockFi filed a lawsuit in New Jersey bankruptcy court against a holding company owned by Sam Bankman-Fried, who was not named personally as a defendant in the suit.

BlockFi's suit claims that the holding company, known as Emergent Fidelity Technologies Ltd., defaulted on its obligations to repay the debts of Alameda Research with shares in Robinhood Markets Inc. as collateral. The arrangement was made three weeks ago before FTX and BlockFi entered bankruptcy. Emergent holds a 7.42% share of Robinhood, per Eikon data.

At a bankruptcy court hearing Tuesday, a lawyer for BlockFi said the company intends to allow customers to resume withdrawals from their digital wallets in the near future and that those funds aren't the property of the company's estate.

Fox Business' Ernie Sadashige and Reuters contributed to this report.