How Celsius’s Fall Tweaked Crypto Investors

Celsius’ filing for bankruptcy this week came as no surprise to virtually no one. Once a platform freezes client assets, it’s usually all over. But just because the fall of this struggling crypto lender didn’t come as a shock doesn’t mean it wasn’t really a big deal for the industry.

In October 2021, CEO Alex Mashinsky said the crypto lender had $25 billion in assets under management. Even as recently as May — despite falling cryptocurrency prices — the lender was managing around $11.8 billion in assets, according to its website. The company had an additional $8 billion in customer loans, making it one of the biggest names in crypto lending globally.

Now Celsius is down to $167 million “in cash,” which it says will provide “sufficient liquidity” to support operations during the restructuring process.

Meanwhile, Celsius owes its users about $4.7 billion, according to its bankruptcy filing — and there’s a hole of about $1.2 billion in its balance sheet.

This goes to show that leverage is one hell of a drug, but by the time you’re sucking up all that liquidity, it’s a lot harder to keep the party going.

Celsius’ fall marks the crypto ecosystem’s third major bankruptcy in two weeks, and it’s being billed as crypto’s Lehman Brothers moment – likening the contagion effect of a failing crypto lender to the downfall of a large Wall Street bank that ultimately predicted the 2008 mortgage debt and financial crisis.

Regardless of whether the implosion of Celsius portends a larger collapse of the largest crypto ecosystem, the days of clients collecting double-digit annual returns are over. For Celsius, the promise of these big returns as a way to onboard new users is a big part of what led to its ultimate downfall.

“They were subsidizing it and taking losses to entice customers,” said Nic Carter of Castle Island Venture. “The returns on the other end were bogus and subsidized. Basically, they were getting returns from [Ponzi schemes].”

Who will get their money back

Three weeks after Celsius halted all withdrawals due to “extreme market conditions” – and days before the crypto lender finally filed for bankruptcy – the platform was still advertising in bulk bold print on its website, annual returns of nearly 19%, which paid out weekly.

“Transfer your crypto to Celsius and you could earn up to 18.63% APY in minutes,” the website read on July 3.

Such promises helped attract new users quickly. Celsius said it had 1.7 million customers in June.

The company’s bankruptcy filing shows Celsius also has more than 100,000 creditors, some of whom lent money to the platform without any collateral to back up the arrangement. Its list of top 50 unsecured creditors includes Sam Bankman-Fried’s trading company, Alameda Research, as well as a Cayman Islands-based investment firm.

These creditors are likely the first to get their money back, if there’s anything to be had – with mom and pop investors holding the bag.

After filing for bankruptcy, Celsius clarified that “most account activity will be suspended until further notice” and that it “was not requesting permission to allow customer withdrawals at this time.”

The FAQ goes on to state that reward accumulations are also halted by the Chapter 11 bankruptcy process, and customers will not receive reward distributions at this time.

This means that customers trying to access their cryptocurrency are currently out of luck. It is also unclear whether the bankruptcy proceedings will ultimately allow customers to recoup their losses. If there is some kind of payment at the end of what could be a multi-year process, there is also the question of who would be the first to get it.

Unlike the traditional banking system, which typically insures customer deposits, there is no formal consumer protection in place to protect user funds when things go wrong.

Celsius specifies in its terms and conditions that any digital asset transferred to the platform constitutes a loan from the user to Celsius. Because there was no collateral Celsius put in place, customer funds were essentially just unsecured loans to the platform.

Also in the fine print of Celsius’s terms and conditions is a warning that in the event of bankruptcy, “any eligible digital asset used in the Earn Service or as collateral under the Borrow Service may not be recoverable” and that customers “may not have any legal remedy or right in connection with Celsius’ obligations.” The disclosure reads like an attempt at blanket immunity from wrongdoing, should things ever go wrong.

Voyager Digital, which has 3.5 million customers and also recently filed for bankruptcy, is another popular lending platform for retail investors with high-yield offerings.

To reassure their millions of users, Voyager CEO Stephen Ehrlich tweeted that after the company went through bankruptcy proceedings, users with crypto in their account would potentially be eligible for some sort of purse containing items including a combination of the crypto in their account , common stock in the revamped Voyager, Voyager tokens, and more. the proceeds they can get from the company’s now-defunct loan to once-major crypto hedge fund Three Arrows Capital.

It’s unclear what the Voyager token would actually be worth, or if it will all come together in the end.

Three Arrows Capital is the third major crypto player to seek bankruptcy protection in US federal court, in a trend that can’t help but beg the question: Will bankruptcy court ultimately be the place where a new precedent in the crypto industry will be set, of sorts? of the regulation by decision model?

Capitol Hill lawmakers are already looking to establish more ground rules.

The senses. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, DN.Y., aim to clarify a bill that establishes a comprehensive framework to regulate the crypto industry and distributes oversight among regulators like the Securities and Exchange Commission and the Commodity Futures Trading Commission.

What went wrong

Celsius’ overarching problem is that the almost 20% APY it was offering customers was not real.

In a lawsuit, Celsius is accused of operating a Ponzi scheme, in which it paid first depositors with money it obtained from new users.

Celsius has also invested its funds in other platforms offering equally high returns, to keep its business model afloat.

A report by The Block revealed that Celsius had invested at least half a billion dollars in Anchor, which was the flagship lending platform of the US dollar-pegged stablecoin project terraUSD (UST). Anchor has promised investors a 20% annual percentage return on their UST holdings – a rate that many analysts have deemed unsustainable.

Celsius was one of multiple platforms to park its money with Anchor, which is a big part of why the cascade of major failures was so big and fast after the UST Project implosion in May.

“They always have to look for yield, so they move assets into risky instruments that are impossible to hedge,” said Nik Bhatia, founder of The Bitcoin Layer and assistant professor of finance at the University of Southern California.

As for the $1.2 billion discrepancy in its balance sheet, Bhatia attributes it to poor risk models and the fact that collateral was sold by institutional lenders.

“They probably lost customer deposits in UST,” Bhatia added. “When asset prices go down, that’s how you get a ‘hole.’ The liability remains, again, poor risk models.”

Celsius is not alone. Cracks continue to form in the lending corner of the crypto market. Carter of Castle Island Venture says the net effect of all of this is that credit is destroyed and withdrawn, underwriting standards are tightened, and creditworthiness is tested, so everyone is withdrawing liquidity from crypto lenders.

“That has the effect of pushing yields higher as credit becomes tight,” said Carter, who noted that this was already happening.

Carter expects to see general inflationary deleveraging in the U.S. and elsewhere, which he says only further argues for stablecoins, as relatively hard money, and for bitcoin, as a really hard money.

“But the part of the industry that relies on frivolous token issuance will be forced to change,” he said. “So I expect the outcome to be heterogeneous across the crypto space, depending on the specific sector.”

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