Character.ai's Bankruptcy Documents Show the Economics of AI Don't Work

# Character.ai's Bankruptcy Documents Show the Economics of AI Don't Work Source: [https://www.404media.co/character-ais-bankruptcy-documents-show-the-economics-of-ai-dont-work/](https://www.404media.co/character-ais-bankruptcy-documents-show-the-economics-of-ai-dont-work/) Character\.ai’s bankruptcy is the one of the first dominos to fall in the long\-foreseen AI bubble\. The circumstances of its bankruptcy are[exactly what critics of AI have been saying would happen](https://www.404media.co/lobotomized-character-ai-is-showing-what-ai-enshittification-looks-like/): Character\.ai lit a huge amount of money on fire running its product, did not bring in a lot of revenue, and faced enormous legal fees after causing harm to its users\. Enshittifying its product to try to make its expenses cheaper did not work, according to a narrative filed in bankruptcy court Tuesday\. [Disney has reportedly offered](https://www.businesswire.com/news/home/20261012656385/en/Character.ai-Initiates-Voluntary-Chapter-11-Proceeding-to-Facilitate-Value-Maximizing-Sale-Process?ref=404media.co)Character\.ai $20 million to license some of its intellectual property; Last year,[Disney sent Character\.ai](http://character.ai/?ref=404media.co)a cease and desist letter demanding it stop using its copyrighted characters without permission\. In 2023, it was valued at $1 billion after raising $150 million in a round led by a16z\. Character\.ai is one of the best\-known AI chatbot companies that has become popular in the AI companion space\. The company has faced various legal problems after being sued by the family of one of its users who killed himself after chatting with a Character\.ai chatbot, and has been the[target of regulators pushing for age verification](https://www.404media.co/44-attorneys-general-to-ai-chatbot-companies-open-letter/)tech because of its popularity with kids\. In its bankruptcy filings, the company says that its enormous legal costs contributed to its bankruptcy, but that even without the legal problems, its business was wildly unsustainable\. [An affidavit filed in bankruptcy court](https://www.documentcloud.org/documents/28809489-18/?ref=404media.co)by Character\.ai CEO Colin Adams noted simply: “Character’s impressive technology is expensive to operate,” and “at all times, Character has struggled with profitability and its operational expenditure has been high\.” The company said that in 2024, the company spent $13\.8 million per month on AI compute; in 2025, it spent $10 million per month on AI compute\. The company’s subscription revenue peaked at $2\.8 million per month, but at times was less than $1 million per month\. Its revenue from all sources, including ads, has peaked at $5\.3 million per month\. The company spent $56\.1 million on compute costs between January and August of 2026 alone and as of August was losing “approximately $8\-9 million per month,” which it said was a massive improvement over the previous year\. The company spent $19\.7 million on employee salaries and benefits during that same eight\-month time period and that a lot of employees quit because they “began questioning Character’s long\-term viability,” according to the company\. Character said that its finances had*improved*to only be losing $8\-9 million per month by taking “significant actions to reduce operational costs and improve revenues” by spending less on compute by simplifying its AI model, laying off staff, and injecting ads into its chats\. In May,[404 Media wrote that Character\.ai’s changes](https://www.404media.co/lobotomized-character-ai-is-showing-what-ai-enshittification-looks-like/)are “what AI enshittification looks like,” with tons of ads, usage limits, guardrails, and “lobotomized” models\. In the bankruptcy filing, Adams essentially admits that this enshittification was the strategy: “Character has, however, taken significant steps to reduce its operating burn, including transitioning inference workloads to lower\-cost GPU capacity and post\-training open\-weight models rather than developing proprietary foundation models\. At the same time, Character reduced its employee headcount,” he wrote\. “In mid\-2025, Character launched in\-app advertising \[…\] in early 2026, Character also introduced in\-app purchases\.” While the lawsuits against Character are significant, they are also not unusual for an AI industry that has been plagued with legal problems relating to the theft of intellectual property[and suggesting self harm](https://www.404media.co/new-study-reveals-the-manipulative-dark-patterns-of-ai-chatbots/)or violence to their users\. In other words, there is nothing in Character’s bankruptcy filings that could not be said about many other AI companies that are spending a huge amount of money on compute without having a revenue model that can support it\. The difference between Character AI and behemoths like OpenAI, Anthropic, Meta, and Google is that those other companies have been able to repeatedly get injections of new cash, or, in the case of Meta and Google, have been able to subsidize their AI products with revenue from their massive advertising businesses\. The company said[in a blog post](https://blog.character.ai/an-update-on-character-ai/?ref=404media.co)that it will continue operating through the bankruptcy process: “The Character\.ai platform remains up and running, and you can continue to access all services at this time\. We're focused on finding the best path forward for our platform and community\.” As frontier models from the big players get better and have fewer guardrails, they will also likely continue to eat into the user base of more specialized products like Character\.ai\. Much of what you can do on Character\.ai you can also do on ChatGPT or with Meta’s Muse, for example\. It’s not clear whether AI giants like OpenAI and Anthropic, or the AI industry in general have gotten too big or too important to fail, but Character’s bankruptcy shows that the runway for second\-tier players is over\. About the author Jason is a cofounder of 404 Media\. He was previously the editor\-in\-chief of Motherboard\. He loves the Freedom of Information Act and surfing\.