How the fall of Celsius pulled crypto investors down

Celsius’s filing for bankruptcy this week came as little surprise. As soon as the platform freezes clients’ assets, it’s usually over. But just because this crypto lender’s fall didn’t come as a shock doesn’t mean it didn’t make a big difference to the industry.

In October 2021, CEO Alex Mashinsky stated that crypto lender had $25 billion in assets under management. Even as recently as May, despite the collapse in cryptocurrency prices, the lender managed about $11.8 billion in assets., according to its website. The firm had another $8 billion. in client loansmaking it one of the world’s biggest names in crypto lending.

Celsius has now dropped to $167 million “cash in hand” which he said would provide “sufficient liquidity” to support operations in the restructuring process.

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

This proves that leverage is a hell of a drug, but the moment you suck up all that liquidity, it becomes a lot harder to keep the party going.

The fall in Celsius marks the third major bankruptcy in the crypto ecosystem in two weeks, and has been referred to as the Lehman Brothers cryptocurrency moment – ​​comparing the effect of the contagion of a bankrupt crypto lender to the fall of a major Wall Street bank that ultimately predicted the 2008 mortgage debt crash and financial crisis.

Whether or not the collapse of Celsius heralds an even bigger collapse of the larger crypto ecosystem, the days of clients collecting double-digit annual returns are over. For Celsius, the promise of these big harvests as a means to attract new users is a big part of what led to its eventual downfall.

“They were subsidizing it and taking losses to bring in customers,” said Nick Carter of Castle Island Venture. “Revenues on the other end were fake and subsidized. In fact, they received income from [Ponzi schemes]. “

Who will get their money back

Three weeks after Celsius put all withdrawals on hold due to “extreme market conditions” — and days before the crypto lender eventually filed for bankruptcy protection — the platform was still advertising on its website. site in large bold print an annualized return of nearly 19% that paid off. comes out weekly.

“Transfer your cryptocurrency to Celsius and you can earn up to 18.63% APR in minutes,” the website says on July 3rd.

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

The company’s bankruptcy filing shows that Celsius also has over 100,000 creditors, some of whom have lent the platform in cash without any collateral to support the deal. The top 50 unsecured creditors include Sam Bankman-Fried’s trading firm Alameda Research, as well as an investment firm based in the Cayman Islands.

These lenders are probably the first in line to get their money if there’s anything up for grabs – with mom and pop investors left to keep the bag.

After Celsius filed for bankruptcy clarified that “most account activity will be suspended until further notice” and that “no authority has been requested at this time to allow customer withdrawals.”

The FAQ goes on to say that the accrual of rewards also stops in the Chapter 11 bankruptcy process, and clients will not receive rewards at this time.

This means that clients trying to access their cryptocurrency have had no luck so far. It is also unclear whether bankruptcy proceedings will eventually allow clients to recover their losses. If there is any payout at the end of what could be a multi-year process, there is also the question of who will be first in line to receive it.

Unlike the traditional banking system, which typically insures customer deposits, there is no formal consumer protection to protect users’ funds when something goes wrong.

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

Also in fine print, the Celsius terms and conditions warn that in the event of bankruptcy, “any eligible digital assets used in the Earning Service or as collateral under the Loan Service may be non-refundable” and that customers “may not have any funds remedy or right in connection with the obligations of Celsius”. The disclosure reads like an attempt at complete immunity from wrongdoing if anything goes wrong.

Another popular lending platform targeted at retail investors with high yield offerings is Voyager Digitalwhich has 3.5 million customers and also recently filed for bankruptcy.

To reassure millions of users, Voyager CEO Steven Ehrlich tweeted this once the company goes through bankruptcy, users with crypto in their account will potentially be entitled to a bag of sorts, including a combination of the crypto in their account, common shares of the reorganized Voyager, Voyager tokens, and then whatever. the returns they could generate from the company’s now-defunct loan to the once-famous crypto hedge fund Three Arrows Capital.

It’s unclear how much the Voyager token will actually be worth, or if any of it will converge in the end.

Three Arrows Capital is the third major crypto player to seek bankruptcy protection in a US federal courtroom, on a trend that can’t help but beg the question: will bankruptcy court end up being the place where a new precedent will be set in crypto sector, in some way or a regulatory model?

Lawmakers on Capitol Hill are already pushing for more ground rules.

Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, DN.Y., seek to clarify bill establishing a comprehensive framework to regulate the crypto industry and distributes oversight to regulators such as the Securities and Exchange Commission and the Commodity Futures Trading Commission.

Something went wrong

The main problem with Celsius is that the almost 20% APR it offered to customers was not real.

in one claimCelsius has been accused of using a Ponzi scheme in which it paid out early contributors with money they received from new users.

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

Report from Blok found that Celsius had invested at least half a billion dollars in Anchor, the flagship lending platform terraUSD USD-pegged stablecoin project has now failed (STU). Anchor promised investors 20% annual percentage yield on their UST holdings – a speed that many analysts called unsustainable.

Celsius was one of several platforms that put their money into Anchor, which is a big part of why the cascade of major failures was so significant and fast after the UST project collapsed in May.

“They always need to generate income, so they convert assets into risky instruments that cannot be hedged,” said Nick Bhatia, founder of The bitcoin Layer and associate professor of finance at the University of Southern California.

As for the $1.2 billion gap in the balance sheet, Bhatia attributes this to poor risk models and the fact that the collateral was sold out from under it by institutional lenders.

“Perhaps they lost client deposits in the UST,” Bhatia added. “When assets fall in value, there is a hole. Responsibility remains, so again bad risk models.”

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

“This leads to higher yields as credit becomes scarcer,” Carter said, noting that we are already seeing this happening.

Carter expects to see general inflationary deleveraging in the US and elsewhere, which he says only further reinforces the importance of stablecoins as relatively hard money and bitcoin as truly hard money.

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