By Adam Atlas
Attorney at Law
In the old days of crypto, individual investors lost their assets. Now, the biggest VCs in finance have gotten their turn. This is no surprise. A particular kind of fever builds up around what is thought to be a great investment in crypto. The projected returns are astronomical, the path to success is paved with unbreakable formulae, and investors are tripping over each other to place bigger and bigger bets.
The whole thing feels like a casino. FTX is just the latest and largest of a string of crypto implosions representing—on my count—at least $800 billion in evaporated investments through platforms like MtGox, Celsius, Voyager Digital, Three Arrows Capital, Terra Luna, Vauld, etc. Knowing I've provided legal advice on crypto for almost 10 years, The Green Sheet asked me to offer insights on FTX, from a legal perspective.
Ironically, had a beginner ISO/payment processor underwriter been assigned to take a look at FTX—before pouring billions of dollars into it—they would have quickly spotted a problem.
The new CEO of FTX appointed to oversee its bankruptcy proceedings, John J. Ray, wrote in his filings, "Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here, […]." If there were no corporate controls or trustworthy financial information, how did those facts elude the big-firm lawyers of the biggest VCs in the nation? I don't know the answer, but I can think of three possibilities.
First, the due diligence didn't happen. Perhaps no one flew to the Bahamas to meet with management of FTX and look at their accounts and books. When crypto is going up, the dubious privilege of investing is dangled before anxious investors with the winning positions going to those who invest the most, the fastest.
Think of the roulette wheel turning already and investors being invited to place their bets or be left out altogether.
Second, the due diligence was done, but the lawyers failed to notice the holes that Ray is now uncovering. In my experience, large law firms are expert at traditional investments with fiat money in normal bank accounts secured by normal assets, like buildings or listed equities. Crypto, however, requires the investigating lawyer to understand a bit more than fiat deal-making; it requires the lawyer to understand how easy it is to fudge questions of who owns what and where the value of assets are actually placed.
Perhaps, the lawyers representing investors into FTX simply didn't know what they were looking at and were therefore unable to provide effective legal advice to their clients.
The third, and most likely possibility, is law firms representing investors into FTX saw there was nothing under the hood, but their VC clients—like gamblers in a casino—insisted on investing all the same.
None of the traditional media like the Wall Street Journal, The New York Times and others are running profiles on lawyers for investors in FTX. The investors are the cream of the crop of VCs such as the following (as reported in The New York Times,www.nytimes.com/2022/11/11/technology/ftx-investors-venture-capital.html): Third Point Ventures, Tiger Global, NEA, IVP, Iconiq Capital, Lux Capital, Mayfield, Insight Partners, Sequoia Capital, SoftBank, Lightspeed Venture Partners, Ribbit Capital, Temasek Holdings, BlackRock and Thoma Bravo.
Surely some of these large firms have something to say to the fintech marketplace, if only a cautionary tale. I have written to the Wall Street Journal to ask this question and haven't received a reply. Realistically, the law firms advising these VCs are not allowed to talk about their advice because it is protected by lawyer-client privilege.
As ISOs and payment processors know very well, the best legal wording often cannot protect against a dishonest business. When processors accept large volumes of high-risk processing without reserves or provide cash advance without a claim on future receivables, money can quickly disappear.
As I have written in this column many times over the years, a contract is not much better than the parties signing it. In FTX it appears that the counter-parties of its investors—and customers—were not trustworthy.
Traditional deal makers might have asked for a face-to-face meeting with SBF to assess his trustworthiness. Perhaps, the rush to invest, and a preference for Zoom over IRL caused investors to side-step those meetings. Would other investors in the same spot make the same decision? Who knows? We can only speculate.
Die-hard Bitcoin and other crypto fans believe that if a user does not exclusively control their private keys, then they do not actually own the coin in the wallets that use those keys. Private keys are the codes necessary to initiate outbound transactions from a crypto wallet.
Hosted crypto wallet providers, like FTX, Binance, Coinbase and others hold onto those keys on behalf of their users. Unhosted crypto wallet solutions, like Ledger and Tezor, make it easy for users to control their own private keys.
Every crypto implosion has been on a platform where user keys and assets are held by a centralized exchange, like FTX. The maxim "Not your keys, not your coin" rings truer than ever now. The problem with just holding your crypto in an unhosted wallet is that you cannot also gamble with it at the same time.
This tension between the security of holding digital assets versus the irresistible allure of gambling them for potentially great returns is likely here to stay.
The great thing about law is that it has studied fraud for centuries. The question for investors is whether they want to use legal tools—such as due diligence, liens, audit rights and legal opinions to protect themselves—or, instead, make big blind bets hoping for a fast buck.
For the record, none of the crypto platforms mentioned in this article took legal advice from our firm (www.bitcoin.law) nor did investors that were also mentioned herein. 
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For further information on this article, please contact Adam Atlas, attorney at law via email atatlas@adamatlas.com or by phone at 514-842-0886.
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