Reports of company bankruptcies within the Web3 sphere are always met with significant concern, capable of significantly impacting a company’s valuation and public sentiment.
What may appear as merely a ripple in mainstream news often reverberates like a bomb within Web3. This heightened sensitivity stems from numerous significant monetary scandals and regulatory actions that have cast a unique spotlight on the space. The most significant of these concerns come from the 2022 downfall of FTX and Alameda Research. These two companies prompted the epic downfall of many other entities, including exchanges, lenders, and mining operations.
Are we now living in a “new normal” where Web3 bankruptcies are just a typical part of our economic lives? Or, conversely, do these announcements have the potential to send financial shockwaves through our community? Furthermore, how common are Chapter 11 bankruptcies throughout the whole United States economic sector?
In this guide, we will explore the process of a Chapter 11 bankruptcy and the frequency at which they occur. We hope to provide you with a macroeconomic perspective outside of the Web3 bubble.
How do Chapter 11 bankruptcies work?
Chapter 11 bankruptcies are also commonly known as “reorganizations”. Unlike Chapter 7 bankruptcies, which may involve liquidation, Chapter 11 allows companies to continue operating while their finances are reorganized. Many Web3 bankruptcies have taken place in the financial or information technology sectors of the economy, and these bankruptcies are handled the same as any other economic sector within the United States.
A company files for Chapter 11 bankruptcy by submitting a petition to the bankruptcy court in the jurisdiction where it is incorporated. The filing will provide detailed information about the company’s assets, liabilities, and operations. As soon as the petition is filed, the company is granted protection, or an automatic stay, from creditors so that they may begin the process of restructuring their debts. This restructuring occurs under the supervision of a bankruptcy court.
The company will then develop a reorganization plan. This is an action plan that will outline how it will restructure its debts and operations to generate a profit again. This plan will need to be approved by the bankruptcy court and the company’s creditors.
Eventually the company may emerge from bankruptcy and continue to operate under the terms of the reorganization plan. Chapter 11 bankruptcies can take from a few months up to five years.
What are the factors that lead to these Web3 bankruptcies?
There are many contributing factors to companies announcing a bankruptcy within the Web3 realm. Economic downturns or industry disruptions may occur within their sector. Moreover, excessive debt burdens and fund mismanagement are also common catalysts that push companies to seek bankruptcy protection.
A black-swan event like COVID-19 pushed many organizations and individuals to their financial limits. Within our sector, the FTX debacle was also considered a black-swan event, contributing to the financial downfall of an unprecedented number of organizations connected to their liquidity.
How common are Chapter 11 bankruptcies?
The United States court data for the year ending in September 2023 highlighted that bankruptcy business filings rose almost 30% from the calculated year prior. Around 17,000 entities filed for bankruptcy between September 2022 and September 2023.
PWC takes a closer look, specifically at Chapter 11 bankruptcies, in their 2024 restructuring outlook. They anticipate that “economic uncertainty” will remain for 2023, with more business downgrades to come. This is due in part to 2021 and 2022 being years that companies benefited from low interest rates and government stimulus funds.
The report highlights an intriguing aspect: despite the fact that Web3 bankruptcies are mainly comprised of financial or information technology firms, their totals together only constitute around 8% of all restructuring filings in 2023.
2024 Outlook
Experts predict that the broader economic impacts such as interest rates and inflation are likely to delay the complete revelation of the anticipated effects on the typical 12-18 month delayed timeline for Chapter 11 restructuring filings.
With that in mind, they anticipate that many organizations that are in financial trouble now will file for bankruptcy in 2024, making this year’s totals higher than 2023.
As blockchains and the Web3 activities surrounding them become a larger share of the global GDP, a rise in bankruptcy filings is expected to become more commonplace. Many of the businesses and startups involved in Web3 are made of up individuals who are like you — they like to take risks. Moreover, given that there will always be bad actors in any financial realm, but especially here, it is advisable to prioritize self-education in this domain.
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