LI crypto startup's funding has an FTX complication

A startup with Long Island roots that is seeking to push cryptocurrency transactions into the mainstream has landed $18 million from 12 venture capital investors just as one of its funders — an affiliate of FTX — spiraled into bankruptcy.

The startup, Fordefi, announced the funding round on Nov. 8, three days before cryptocurrency trading platform FTX and its affiliated hedge fund, Alameda Research, filed for bankruptcy. With the bankruptcy filing coming on the heels of the venture round, the funding by Alameda could be subject to a "clawback," a Long Island securities lawyer said.

Fordefi's headquarters are listed by S&P Capital IQ as Woodmere, though a company spokesman said that chief executive Josh Schwartz has been operating from a coworking facility in Manhattan.

"Alameda made a small investment in Fordefi and received shares of preferred stock in consideration for their investment on the same terms as other investors in the financing," a company spokesman said in an emailed statement. "We have not been contacted by anyone representing Alameda in connection with their investment since the bankruptcy filing."

An undated blog post on Fordefi's website  acknowledged that the FTX implosion had "created a seismic shift in the digital asset landscape" that has spooked some traditional financial institutions.

"The future of crypto looks bleaker than it has in years," the blog post said, calling the FTX episode a reminder that "bad actors can take advantage of hype and public adulation to cause harm at a massive scale."

Fordefi's association with FTX and Alameda, both accused of illicit activities, could make it more difficult for the company to attract future funding rounds, said David Sacco, who teaches finance at the University of New Haven. 

Fordefi was one of dozens of early-stage companies funded by Alameda. The leader of Fordefi's $18 million funding round was Lightspeed Venture Partners, a firm on Sand Hill Road in Menlo Park, the hub of Silicon Valley venture capital. Lightspeed did not respond to a request for comment.

FTX co-founder Sam Bankman-Fried, 30, was arrested in the Bahamas last week on criminal charges that he siphoned money out of customer accounts for his own purposes and was extradited to New York. Carolyn Ellison, 28, the former chief executive of Alameda, pleaded guilty to charges including wire fraud, securities fraud and commodities fraud.

Securities and Exchange Commission charges outline a broad conspiracy stretching back to at least 2019 in which Bankman-Fried and Ellison moved customer funds from FTX to Alameda and its affiliates. The bankruptcy filing by FTX showed that Alameda lent Bankman-Fried and other executives billions of dollars for their personal use. At the same time, FTX was raising billions of dollars more from unknowing investors and Alameda was borrowing billions from third-party lenders. After publication of a story by cryptocurrency publication CoinDesk in November that raised concerns about the firms' solvency, the schemes unraveled.

Fordefi says it is developing a digital wallet designed to allow secure trading, lending and other decentralized financial transactions executed through "smart contracts." 

More secure transactions?

Had such decentralized finance structures been in place, the Fordefi blog post said, it might have blunted some of the worst impacts of the FTX "implosion" by allowing end users to oversee their own transactions without the intervention of centralized institutions like FTX. 

Decentralized finance seeks to enable transactions such as loans or purchases to be conducted without the need for a financial institution to serve as an intermediary. For instance, a smart contract encoded in blockchain software could require that a set amount of the cryptocurrency Ethereum must be transferred to an account before ownership of a property or a vehicle is transferred to a buyer.

Fordefi's digital wallet is designed to lock down the security of such transactions.

One Long Island securities lawyer said at least some of the blame for the FTX fiasco must be shouldered by top-tier venture capital firms that lavished funding on FTX without requiring the "guardrails" typically negotiated in such transactions.

"There's nothing unique necessarily about the crypto product," said Alon Kapen, a partner at Uniondale-based Farrell Fritz. "The issue here is less about crypto and more about old-fashioned governance."

Kapen said terms he negotiates in funding rounds routinely include venture capital  representation on the board of directors that's proportional to ownership, and veto power over related-party transactions such as those alleged between FTX and Alameda.

It was unclear what portion of Fordefi's $18 million funding round was contributed by Alameda, but Kapen said that piece of the funding could be subject to a "clawback" in bankruptcy court.

"Those dollars may be tainted," he said. "It may be part of what was diverted away from customer accounts by Sam Bankman-Fried."

By Ken Schachter

kenneth.schachter@newsday.comkschach

Ken Schachter covers corporate news, including technology and aerospace, and other business topics for Newsday. He has also worked at The Miami Herald and The Jerusalem Post.