Three weeks after funds freeze, Celsius nears its melting point

“Banks are not your friends” was the slogan printed on Alex Mashinsky’s t-shirt at last year’s Web Summit in November, when his company was one of the biggest cryptocurrency banks in the market, reaching a peak of US$12bn in deposits and a valuation of more than US$3bn.

Since then, Mr. Mashinsky, the founder, and CEO of Celsius Network, has faced one of the biggest threats to banks – a bank run, as customers rushed to take out funds amidst the collapse of major cryptocurrencies. Due to the unstable position of the company, Celsius was forced to halt withdrawals, and three weeks on, this major crypto platform is on the verge of collapse.

Within this short period, other crypto platforms have found themselves in similar situations, telling their users that they are unable to withdraw funds or have had to set a limit on the amount customers are able to take out.

Babel Finance abruptly suspended withdrawals on the 17th of June due to “unusual liquidity pressures,” Finblox sanctioned a US$1500 monthly withdrawal limit, CoinFLEX had paused withdrawals until the 30th of June, however, then stated that they “need more time” and are still blocking withdrawals, and Voyager Digital Ltd. has filed for bankruptcy.

These crypto companies, including Celsius, have ballooned in size and profitability in recent years by offering mouth-watering interest rates on deposits and huge crypto backed loans.

However, as the price of major cryptocurrencies, such as Bitcoin and Ethereum, collapsed in June, due to a massive sell-off provoked by recession concerns, these companies are struggling to fund their mass amounts of customer withdrawals.

To make matters worse for depositors, these crypto lenders lack investor protection and a legal oversight, such that “deposits are not guaranteed by the federal government,” writes Vicky Ge Huang, from The Wall Street Journal.

In 2017, Mr. Mashinsky established Celsius Network as an alternate to the traditional banking system.

He, along with co-founder Daniel Leon, wanted to establish something that “acts in your best interest, a place where you can actually have your money work for you, instead of you working for your money,” Mr. Mashinsky stated at last year’s Web Summit.

A platform that repeatedly claim is “not a bank,” and that their customers should “unbank themselves.”

However, like a bank, Celsius allows its users to deposit cryptocurrencies in exchange for interest payments and offers loans, in which they charge interest for.

Celsius also generates profits in a similar way to how a bank does. Celsius will take deposits, loan them to other institutions and crypto exchanges for higher interest rates than what they pay to depositors.

Where Mr. Mashinsky is accurate with his statement, “we are not a bank,” is the much higher interest rates users will receive for deposits, compared to traditional banks.

Celsius offers rates of 10%, and in some cases, up to 15-18%, on deposits per year. This is 100x the interest rate that a bank provides, for the same deposit.

However, because of this generous business model, Celsius was returning roughly 80% of their profits back to their depositors.

The company also created a cryptocurrency token – CEL, which people can invest into, as they wanted to provide additional liquidity as a ‘safety net’ to their business model.

Holding the coin also promised customers higher guaranteed rates and lower costs.

On the back of the crypto bull-run and this generous business model for their users, Celsius was able to secure a valuation of US$3.25bn by the end of last year, raise US$750mn in the month of November, led by West Cap and Caisse de dépôt et placement du Québec (CDPQ) and invest US$300mn into its bitcoin mining capabilities as their assets continued to grow.

However, Celsius didn’t take into account the volatility of the cryptocurrency markets.

Initially, the Financial Times reported that from March to May US$1bn flew out of the company through customer withdrawals.

Then, Luna Collapsed in early May, which was due to unsustainable high yields – similar yields to what Celsius offered, resulting in further withdrawals.

But then, Celsius’ ‘safety net’, the CEL token, began to plummet, decreasing from US$2.02 to US$0.81 over the month of May, creating more hazards if more people want to withdrawal funds.

Because of the crash of their safety net, Celsius began taking out more loans to help pay for withdrawals.

Mike Burgersburg, a crypto researcher, posted a tweet documenting that FTX, a Bahamian cryptocurrency exchange, sent US$50mn $USDC to Celsius as a loan. This resulted in further withdrawals, and hence cause Celsius to search for more loans.

Eventually this became overbearing. On June 12th, Celsius blocked withdrawals, citing, “extreme market conditions,” as the main reason, and the Celsius token fell another 50% from there.

It was also revealed that Celsius had further high-risk operational activities, leading to demise.

Firstly, Celsius’ internal documents revealed a structural ratio of US$19bn in assets to US$1bn in equity. According to Matt Levine from Bloomberg, “the median assets-to-equity ratio for all the North American banks in the S&P 1500 Composite index was about 9:1, about half that of Celsius, according to data from FactSet.”

Eric Budish from University of Chicago’s business school, drew similarities to the Global Financial crisis, stating, “It strikes me as diversified as the same way that portfolios of mortgages were diversified in 2006…It was all housing—here it’s all crypto.”

Further documents reveal that Celsius had undercollateralized their lending. Unlike banks, who overcollateralize their loans, requiring homeowners that hold a mortgage stake their house as collateral, which is valued at a much higher price than the loan itself, Celsius only required a 50% collateral stake of its US$2.7bn loans for their business borrowers.

In addition, Celsius would use “some of that collateral to borrow more money itself, a process known as rehypothecation, adding additional risk,” Mr. Levine writes.

Over the past week, Celsius has managed to secure US$142.8mn to pay to creditors, however, still owes a further US$82 million to a creditor called Maker, which sells stablecoins.

According News.com.au, the CoinTelegraph are reporting that the firm has lost $667.2 million so far from the crypto bear run.

Celsius was also forced to lay off 150 staff members.

Celsius has reportedly hired restructuring lawyers to save the company.

US state regulators in Texas, Alabama, Kentucky, New Jersey, and Washington have also began investing Celsius’ actions to ban withdrawals.

Echoes are growing for more regulation to be put in place to avoid future instances of crypto collapses.

“Until there are capital requirements, those running these businesses will be enticed to take on more and more leverage to generate more returns. When the market turns we’ll see them wiped out again,” Rand Low, quantitative risk modeller at BlackRock.