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Celsius Network ($CEL) Collapse – The End Of Centralized DeFi?

Celsius Network is considered one of the largest gateways to crypto, among other big players such as BlockFi and Nexo, with $864 million worth of venture capital raised and over $3 billion worth of funds custodied for 1.4 million customers. Offering attractive yields, simple to use UI, and promises of security and transparency, it was truly the perfect crypto on-ramp for less experienced crypto users, abstracting away the complexities of DeFi (Decentralized Finance), and offering only pure and straightforward DeFi yields.

However, their asset management practices have recently been brought to light. As it has recently surfaced, their risk management strategy heavily relied on continued bullish crypto narratives pushing prices upwards, leaving them unprepared for significant drawdowns. Coupled with what is colloquially known as “degenerate trading” strategies, Celsius is now running a risk of liquidation and potential bankruptcy.

Some people believe Celsius will be yet another big platform to go down during this bear market, potentially pushing crypto prices even lower than before, and likely resulting in a further liquidation cascade that could destroy protocols, VCs, investment funds, and many others. As the story is still unfolding, let’s take a look at where Celsius is at right now, and where it might end up.

For another perspective on the situation on Celsius Network and how events may unfold, check out Michael’s analysis: 

Celsius Network – Then And Now

What is Celsius Network?

Celsius Network ($CEL) is a one-stop shop fintech app that offers the ease-of-use benefits of CeFi (Centralized Finance) with the best of what DeFi can offer, all under a single hood. In essence, it can be considered a centralized DeFi platform, which allows users to deposit their funds into custodial wallets on Celsius Network, and offers a range of DeFi services all in one place, available at the click of a button. They offer anything from simple token swaps to more advanced features such as amazingly high yields on stablecoins and cryptocurrencies, as well as crypto-backed lending and borrowing for individuals and institutions.

With an easy-to-use dashboard, free crypto transfers between accounts, a great selection of DeFi features, and a 6 days a week customer service, Celsius has managed to offer a truly incredible product to more than a million customers, gathering respect from the industry and attracting a lot of venture capital as a result. So what went wrong?

The Demise of Celsius Network?

The demise of Celsius can be summed up in three parts, with its problems really starting to surface during the LUNA collapse, followed by a slow unravelling of Celsius’ overleveraged and poorly planned out WBTC and ETH/stETH positions that have led them to a complete lockdown of their platform.

LUNA/UST Giga Yields

Luna, through its Anchor protocol, promised a “risk-free” 20% interest on their USD-pegged stablecoin, UST, which was a highly popular product right up until its collapse. As it turns out, Celsius was also taking advantage of these high yields, which consequently allowed them to offer high yields to their own customers while taking some profits for themselves.

Although the details of this part of the story are a bit less clear and have been denied by the founder of Celsius, on-chain investigations by firms such as The Block Research, Hoptrail, and Nansen revealed that Celsius was staking up to $535 million worth of UST on the Anchor protocol. Reportedly, prior to the full-on depeg of the UST, Celsius had managed to pull out their funds without too much damage, leaving the Terra ecosystem with a half a billion-dollar hole in their pockets. It seems that Celsius managed to get out of that situation mostly unscathed. However, this should’ve served as a red flag that indicated what kind of risk Celsius is willing to take on.

WBTC as DAI collateral

This one’s also pretty straightforward. Celsius has been using their customer’s WBTC (wrapped BTC on Ethereum) as collateral to borrow DAI on the Maker protocol in order to stake the DAI stablecoin for very favorable yields. Everything had been going great until BTC started to tumble down at an accelerated pace after UST collapsed. As the price tumbled, it was cheaper for Celsius to keep adding to the collateral instead of paying off their DAI debt, losing some capital and the DAI yields. Likely in expectation for a trend reversal or at least a short-lived BTC relief rally, they kept adding to the collateral, which itself was subsidized by their customer’s funds. 

stETH & locked ETH

Celsius offered their customers an attractive <8% yield on ETH while the best ETH staking deal one could get was by staking their ETH on the Ethereum PoS Beacon chain, which offers ~4.2% yield at best. So how could they possibly deliver such an incredible deal for their customers?

The answer was stETH – staked ETH, a liquid ETH derivative offered by Lido Finance. In essence, it’s a fully collateralized representation of ETH staked on the Ethereum PoS Beacon chain. In the post-Merge era, when staked ETH withdrawals will be enabled, 1 stETH will be redeemable for 1 ETH. This allows anyone to earn a yield on ETH offered by the Beacon chain without running the staking infrastructure. The issue arises from two interlinked facts – stETH’s dollar value is not pegged to ETH’s dollar value & stETH cannot be redeemed for ETH, only vice-versa is possible.

So Celsius was doing three things with their customer’s ETH to generate the exorbitant yields:

  1. Lending out ETH and earning interest on DeFi protocols (27% of their total ETH);
  2. Swapping them for stETH to generate ETH staking yields and at the same time lending out stETH to provide liquidity and earn interest on Curve Finance, a decentralized crypto exchange. (44%); and 
  3. Staking ETH on Beacon chain, rendering it illiquid for at least a year or whenever The Merge happens and the ETH gets unlocked. (27%).

The current issue Celsius is facing is the fact that while swapping an equivalent amount of ETH for stETH, stETH currently is not trading for the same dollar value as its ETH equivalent, due to several reasons. As a result, they’re currently in possession of roughly $0.94 for every 1 $ worth of ETH they owe to their customers. On paper. In reality, it’s much worse than that. Celsius holds ~445k stETH, which is currently valued at $540 million and cannot all be swapped for ETH on Curve Finance pool due to lack of liquidity.

So long story short, Celsius was lending 27% of their ETH on DeFi, and swapped 44% of their ETH for stETH, which is now worth less than ETH and cannot even fully be exchanged back to ETH on an exchange such as Curve Finance. As a result, most of Celsius’ ETH is illiquid.

Celsius Liquidity Crisis

The situation is getting direr by the day for Celsius. At the same time as BTC and ETH prices are tumbling, their ETH liquidity is drying up and they’ve had to top up their WBTC collateral several times from 22k all the way down to 14k to keep margin calls at bay.

To do this, they’ve had to put all withdrawals, swaps and transfers between accounts on hold since 12th June 2022, thus completely locking users out of their assets. This move was done to prevent a bank run, which would’ve completely drained Celsius of their holdings without being able to allow their clients to fully redeem their deposits for whatever Celsius was holding on-chain due to their liquidity crisis, leaving many of them empty-handed. Although shutting down withdrawals was probably a prudent move, given how much worse it would’ve been both for Celsius and the customers had they not done that, Celsius is now stuck between a rock and a hard place.

US regulators issue consumer alert against Celsius Network

The Department of Financial Regulation of the state of Vermont (DFR) has issued a consumer alert encouraging investors of Celsius Network to proceed with caution. In the alert, the DFR states its belief that Celsius is “deeply insolvent and lacks the assets and liquidity to honor its obligations to account holders and other creditors”. In relation to this, the DFR referred to Celsius’ activities of deploying consumer assets towards risky and illiquid investments, trading and lending activities, and compounding these risks by using these assets as collateral for additional borrowing for leveraged investments. The DFR also stated their belief that Celsius has been involved in offering cryptocurrency interest accounts to retail investors without proper licensing and registrations. As a result, there is currently an ongoing multistate investigation of Celsius and its previous activities.

Can Celsius still be saved?

Celsius does seem to be trying to increase its assets by repaying its loans in order to release funds put up as collateral. As of 12th July 2022, Celsius has repaid Aave 146m USDC and more than 53M DAI, meaning that it can now withdraw its collateral of almost 6,000 wBTC, nearly 55,000 ETH and millions of dollars worth of other tokens. Celsius has also repaid Compound around 120m DAI in order to withdraw the 4,400 wBTC it posted as collateral. In addition, Celsius has completely settled its debts to MakterDao in the sum of $190m in DAI.

However, from the consumers’ point of view, Celsius remains at a standstill with withdrawals, swaps, and transfers still being halted.

There are several options on the table for Celsius, none of which look particularly appealing, but some are certainly worse than others. They could subsidize their liquidity gap by raising more external funding and acquiring a loan. An acquisition offer has also been advertised by one of their competitors, Nexo, who have publicly made an offer to acquire their assets in order to provide immediate liquidity to Celsius clients. And there is the bankruptcy option, which could also offer a relatively easy way out for the company.

Celsius files for Chapter 11 bankruptcy

On 13th July 2022, Celsius Network announced it and some of its subsidiaries had filed for bankruptcy in the Southern District Court of New York. In its announcement that Celsius had filed for Chapter 11 protection. The filing of Chapter 11 bankruptcy protection means that Celsius can continue operating its business and restructure its obligations.

The Company also states it has US$167m cash on hand to support operations during the restructuring processes. It hopes that through the process, it would stabilize its business to maximize value for all its stakeholders.

Will Celsius users get their cryptocurrencies back?

In announcing Celsius Network’s decision to file for bankruptcy, the Company’s Board of Directors justified its earlier decision to pause trading and withdrawals on its platform to “… stabilise its business and protect its customers”. Adding that, “Without a pause, the acceleration of withdrawals would have allowed certain customers- those who were first to act- to be paid in full while leaving others behind to wait for Celsius to harvest value from illiquid or longer-term asset deployment activities before they receive a recovery.”

In an interview with Cointelegraph, Danny Talwar, head of tax at Koinly has expressed concerns that Celsius may be like Mt.Gox, where since its collapse in 2014, users still have not seen any of their funds returned.

Celsius has so far not made any announcement as to whether or not they will reopen the platform to allow customers to withdraw their cryptocurrencies. In their blog post issued on 14th July 2022 after their announcement that they would file for bankruptcy, Celsius stated that:

“Most account activity will be paused until further notice. Withdrawals, Swap, and transfers between accounts will remain paused, and rewards will stop accruing as of the date of the filing. Celsius is not requesting authority to allow customer withdrawals at this time.”

Celsius Network blog post

Looking forward, Celsius states that they “…intend to put forward a plan that restores activity across the platform, returns value to customers, and provides choices.”

Celsius lawyers: Users gave up legal rights to their cryptocurrencies

Celsius Network’s legal representatives stated that retail users who had Earn and Borrow accounts with Celsius had transferred the title of their cryptocurrencies to them under its terms of service. As a result of the users’ agreement to these terms when opening a Celsius account, Celsius Network can “use, sell, pledge, and rehypothecate those coins” as it wishes.

According to a tweet from Kadhim Shubber, a report from the Financial Times, Celsius Network’s lawyers also stated that its recovery plan would involve HODLing. According to them, customers would be interested in remaining long in crypto throughout this winter so that they can realise their recovery when the market recovers.

For more insights on whether Celsius will make a comeback, check out our latest video: Celsius will come back? Voyager users won’t get their crypto?

Celsius leaks client emails

On 26th July 2022, Celsius emailed its customers informing them of an email leak. According to Celsius’ email, an engineer at one of its vendors, Customer.io had leaked Celsius’ client email addresses to a third-party bad actor. Celsius had not disclosed how many emails were disclosed or to which platform they were leaked.

Celsius users are being warned by the crypto community that they may receive phishing attacks in their compromised emails. These are emails sent by malicious actors to entice victims into either revealing more personal data or clicking links to websites that will install malware onto their devices to steal or mine cryptocurrencies.

Profiting off the Celsius collapse? What is #CelShortSqueeze?

The Twitter trend #CelShortSqueeze has been trending even before Celsius Network filed for Chapter 11 bankruptcy protection on 13th July 2022. #CelShortSqueeze appears to have been set up as a grassroots movement by $CEL token supporters or traders that were liquidated by $CEL backed loans.

The #CelShortSqueeze movement is an attempt by Celsius supporters to make it harder to short the $CEL token. They do this by encouraging other Celsius supporters to buy $CEL on cryptocurrency exchanges such as FTX or Uniswap, and to send the tokens to private wallets. The purpose of this is to take the $CEL tokens out of circulation of centralized exchanges. This is so that spot shorters intending to borrow $CEL from exchanges then selling them to buy them at a lower price later when they return the token are forced to look to decentralized exchanges where users can set the sell prices.

The #CelShortSqueeze movement seems to be effective in propping up $CEL token prices at or over 80 cents despite the news of Celsius filing for bankruptcy protection. Whilst prices initially dipped to 48 cents right after the bankruptcy news came out, the #CelShortSqueeze supporters helped bring back prices to 80 cents and over.

In a recent win for the #CelShortSqueeze movement, prices of $CEL pumped to $1.42 on 29th July 2022, the highest in almost 1 month.

The #CelShortSqueeze movement shows what retail investors can be capable of when they band together through the power of social media. There is a lot of uncertainty right now as to what will happen to the $CEL token as Celsius Network is figuring out how to restructure and rescue the company. The restructuring process can take years and it is unknown when Celsius will re-open withdrawals to customers. So Celsius holders are certainly hoping that the #CelShortSqueeze movement does not lose steam until then.

Conclusion

What becomes of Celsius going forward is unclear. However, what is clear is that time and time again we get to witness the extreme importance of the age-old rules of crypto – be wary if something seems too good to be true, and never put in more than what you can afford to lose. 

Doing your own research is incredibly important, as it’s easy to get swept up in the hype. Thinking critically and understanding the fundamentals can help you avoid a lot of heartache in the future.

The post Celsius Network ($CEL) Collapse – The End Of Centralized DeFi? appeared first on Boxmining.