The devastating collapse of the second-largest cryptocurrency exchange in the world, FTX, has sent shockwaves across the entire crypto industry. Several major crypto platforms such as Genesis, CoinShares, Coinbase, Galaxy Digital, and others are reeling under the effects of the FTX meltdown.

The latest addition to the list of casualties from this mega black swan event is BlockFi. The crypto lender filed for Chapter 11 bankruptcy on Monday, November 28, after substantial exposure to FTX resulted in a massive liquidity crisis on the platform.

However, for most experts, the bankruptcy filing doesn't come as much of a surprise. The fate of the two firms seemed entwined ever since FTX offered to help when BlockFi was in trouble in June this year. As such, the crypto lender's downfall has been a story in the making for months, and this article will explain why.

Let's start from the beginning

In its heyday, BlockFi had three times the number of employees as FTX. The crypto lender had also secured $350 million at a $3 billion valuation in March 2021. A couple of months later, the company announced its plans to go public and expand to Asian markets as well. However, things started to take a turn for the worst in 2022.

The company was forced to cough up $100 million as a settlement with the SEC after allegations surfaced that its high-yield crypto lending product violated state and federal securities laws. The crypto winter was also pretty harsh on BlockFi, pushing the firm to lay off around 20 percent of its employees as its valuation dropped from $3 billion to $1 billion by early June 2022.

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The Terra meltdown, the beginning of the end

The Terra meltdown in May made things worse. The platform's native cryptocurrency, LUNA, and its algorithmic stablecoin Terra USD (UST) crashed to $0 almost overnight. This sent several crypto firms reeling, including crypto hedge fund 3 Arrows Capital (3AC). Now, BlockFi was a large lender to 3AC and was forced to absorb around $80 million in losses when the hedge fund filed for bankruptcy.

Moreover, FUD from the Terra meltdown sent investors on a withdrawal spree. This created a liquidity crisis at BlockFi, forcing the lender to cut down on its employee strength further. At this point, FTX extended a helping hand to the beleaguered crypto lender.

On June 30, FTX provided BlockFi with a $400 million revolving line of credit, along with the option to acquire the troubled lender for up to $250 million, subject to the firm's future performance. At the time, FTX seemed like a knight in shining armour, but in hindsight, the deal was the beginning of the end for BlockFi.

A few months later, FTX is filing for bankruptcy

Earlier this month, FTX paused withdrawals after it ran into considerable liquidity issues. A week or so later, the struggling crypto exchange filed for Chapter 11 bankruptcy, and this spelt nothing but bad news for BlockFi.

As soon as FTX paused withdrawals, BlockFi followed suit, stating that it would "not able to operate business as usual." BlockFi had significant exposure to FTX, especially after the bail-out deal from a few months ago.

Firstly, BlockFi could no longer tap into the $400 million credit facility, which it had never fully drawn out. Moreover, the crypto lender had assets that were now frozen on FTX. To make matters worse, BlockFi's bankruptcy filing claims Alameda Research defaulted on $680 million in loans, "the recovery on which is unknown". Alameda Research is FTX's sister concern.

All these factors put together forced BlockFi to file for bankruptcy yesterday, Nov 28. According to its filing, the company owes between $1 and $10 billion to more than 100,000 creditors. BlockFi's largest creditor is the Ankura Trust, to which it owes a whopping $729 million.

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The tainted relationship continues

Just hours before filing for bankruptcy, BlockFi filed a suit against Emergent Fidelity Technologies, Sam Bankman-Fried's holding company. BlockFi demands that Emergent turnover shares in Robinhood that the FTX founder allegedly pledged as collateral just days before his exchange collapsed.

According to the suit, BlockFi entered into an agreement with Emergent on November 9, where the latter guarantees payment by an unnamed borrower, pledging an unnamed common stock as collateral. Supporting correspondence included in the court filing identifies the borrower as Alameda Research.

Further, additional loan documents identify the collateral in question as SBF's stake in the online trading company, Robinhood. SBF bought 7.6 percent of Robinhood earlier this year and was looking to offload the same to raise money before FTX's collapse, said the FT report, citing two sources familiar with the matter.

The way forward for BlockFi

To begin with, BlockFi does not plan on taking out a loan to fund itself while under court protection. Instead, the crypto lender has sold about $239 million of its cryptocurrency. According to the bankruptcy filing, these proceeds take the beleaguered firm's cash at hand to $256.5 million, which should provide sufficient liquidity to support specific operations during the restructuring process.

In addition, the firm is also looking to lay off 292 of its employees, which is two-thirds of its workforce, to cut down on operational costs. However, only time will tell how things will turn out for BlockFi customers and creditors.

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(Edited by : Anushka Sharma)