How did Celsius become “deeply insolvent”

Rick Steves

After the Terra/LUNA collapse, Celsius Network has become the center of attention amid the ongoing ‘crypto winter’.

Last month, the crypto lender indefinitely paused all transfers and withdrawals due to “extreme market conditions”, thus raising concerns about risk management and solvency within both the CeFi and DeFi spaces.

Despite the alarm, Celsius has been aggressively repaying its loans to major lenders, including MakerDAO and Aave. By repaying the MakerDao loan, Celsius freed up $440 million of collateral pledged against the loan, denominated in wrapped bitcoin (WBTC) tokens. By paying down the $81 million debt to Aave, Celsius freed up 410,000 stETH tokens in collateral, worth $426 million. Outstanding debt dropped to $59 million.

Users’ funds remain locked, however, prompting Vermont’s Department of Financial Regulation (DFR) to warn consumers to proceed with caution as they believe “Celsius is deeply insolvent and lacks the assets and liquidity to honor its obligations to account holders and other creditors.”

“The Department is aware of reports that Celsius has consulted with insolvency counsel and is considering a bankruptcy filing. If you are a Celsius customer, a bankruptcy filing could affect your investor rights and the value of your Celsius interest account balances. You should consult your own counsel if you have questions about your individual situation and how a bankruptcy proceeding could affect your investment in Celsius”, said the DFR statement.

How did it come to this?

According to a report by blockchain analytics firm Arkham Intelligence, Celsius used its customers’ funds worth $534 million to execute “high-risk leveraged crypto trading strategies” through a third-party asset manager and these strategies “resulted in apparent losses of $350 million when the asset manager returned capital”. Losses correspond to $210 million at current prices.

The report suggests these losses may be part of Celsius’ liabilities, leaving the lending platform “short of its customers’ deposited assets, let alone the interest it guaranteed them”. In addition, from the over US$1 billion deployed in DeFi, Celsius lost more than US$100 million to hacks, the analysis said.

KeyFi, led by founder and CEO James Stone, was the third-party that managed “billions of dollars in customer crypto-deposits in return for a share of the profits generated from those crypto-deposits”, according to the lawsuit filed by Stone against Celsius last week.

The “handshake deal” in August 2020 led to hundreds of millions of dollars in crypto-assets flowing to a wallet on the Ethereum blockchain set up by Celsius and going by the name of “0xb1”.

According to court documents, Celsius executives “repeatedly assured” KeyFi’s James Stone that the crypto lender was doing proper risk management by entering the necessary hedging transactions to ensure price fluctuations of certain crypto assets would not materially and negatively impact the company or its ability to repay depositors.

“But these promises were lies. Despite its repeated assurances, Celsius failed to implement basic risk management strategies to protect against the risks of price fluctuation that were inherent in many of the deployed investment strategies”, Stone stated, pointing to “multiple incidents” in which Celsius’ “failure to perform basic accounting endangered customer funds.”

In addition, the lawsuit exposes an alleged price manipulation scheme by Celsius to inflate the price of its native digital coin, CEL, used on the platform for interest payments to users.

“The purpose of this scheme was both fraudulent and illegal: Celsius induced customers to be paid in CEL tokens by providing them with higher interest rates,” the lawsuit claims. “Then by purposefully and artificially inflating the price of the CEL token, Celsius was able to pay customers who had elected to receive their interest payments in the form of the CEL token even less of the crypto-asset.”

The plaintiff also accuses Celsius of running a “Ponzi scheme” by offering double-digit interest rates in order to lure in new depositors whose funds were used to repay earlier depositors and creditors.

This allegedly followed the “massive liabilities” to depositors incurred due to failure to hedge against trading risks and the ‘bank run’ amid the crypto sell-off.

“Thus, while Celsius continued to market itself as a transparent and well-capitalized business, in reality, it had become a Ponzi scheme”, the plaintiff alleged.

DeFi space faces growing pains

Decentralized finance is a nascent and unregulated industry. Scandals like Terra/LUNA and Celsius Network were bound to happen and take a toll on trust within the space.

It is up to solid firms offering DeFi and CeDeFi solutions to lead the way toward a mature ecosystem of borrowers, lenders, better business models and proper risk management.

Finance Feeds spoke with a YouHodler spokesperson about the collapse of Celsius, the current sentiment in DeFi, and how there are different business models that lead to different outcomes when it comes to events such as the ‘crypto winter’.

“On our platform, the Celsius event triggered a chain reaction of withdrawals. Many YouHodler clients wanted to withdraw their funds and we understand why given the recent events surrounding Celsius.

“However, we do want to clarify that we have a much different business model than Celsius. We never use our client’s funds for activities outside of the platform to make a profit. In our business model, we keep everything inside the platform. That way, we never have any liquidity or balancing issues. We don’t lock our client’s funds either. Deposits and withdrawals are open 24/7. Of course, we did experience some delays in processing that day (as did everyone due to network congestion) but in general, everything was very smooth and fast.

“We don’t see the crypto selloff as a problem except for those companies that were directly affected. We’ve been through this many times before. This is just another cycle and just another period of volatility. We remain extremely positive about the future of this industry. It will only continue to mature, grow stronger, and healthier.”

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