👉 The news. US giant Celsius has suspended operations and is preventing clients from accessing their funds.
👉 The background. The collapse of the LUNA/UST ecosystem and the fall in prices are threatening the solvency of many investment companies.
👉 Why it matters. These events are lifting the veil on the very risky strategies of some of them.
Celsius, what's that?
Celsius is an American start-up that allows you to lend or borrow cryptocurrencies in exchange for interest paid each week. Its operation is similar to that of a bank, with the difference that the company founded in 2017 by Alex Mashinsky is not regulated and has no solvency constraints or supervision over the management of funds.
"Celsius positions itself as a network or lender, but its market operations actually look a lot like those of a highly leveraged hedge fund," describes analytics firm CoinMetrics. "User deposits are actively managed and deployed on decentralised finance (DeFi) platforms to ensure its products achieve double-digit returns," it continued in a note published on Tuesday.
Celsius had 1.7 million customers worldwide and $12 billion in funds under management at the beginning of May.
What's happening to it?
After several weeks of uncertainty, Celsius announced on Monday morning the suspension of all its activities: its customers can no longer withdraw or exchange their cryptos. "We are taking this necessary step for our entire community to stabilise liquidity and operations while taking steps to preserve and protect assets," the company said in an email sent to customers. No date for the reopening of services was given.
Like a bank that fears a "bank run" by closing its counters, Celsius preferred to suspend its operations to prevent all its customers from withdrawing their assets at the same time.
Why is its credibility being called into question?
As traditional arbitrage tools have lost interest in recent months (Grayscale's GBTC in particular), Celsius has ventured into exotic strategies to maintain particularly attractive returns. Until a few weeks ago, the company was offering rates of return of up to 18% per annum! 🤨 "When the market structured, rates tightened and they put their cash into many risky products, such as UST, stETH and quantitative strategies," Charlie Meraud, boss of market maker Woorton, explains today.
On 3 May, just days before the collapse of the LUNA/UST ecosystem, on-chain analysts revealed that Celsius had sent the equivalent of $275 million into the Anchor protocol (offering unsustainable returns of 19% on the UST stablecoin). This revelation fuelled the first rumours that some of the industry's heavyweights, led by Celsius, had been affected and that their solvency was at risk.
Given the opaque nature of Celsius' operations, there was no way of knowing for sure at the time whether the company was insolvent, but the mere mention of this hypothesis undermined its credibility and prompted many users to withdraw their funds.
Why has the situation worsened in recent days?
To offer their customers a return, "3.0 banks" like Celsius place their customers' cash in DeFi protocols. Here's an example to help you understand the mechanics: Celsius deposits its users' bitcoins in Aave as collateral to borrow stablecoins and grow them in other protocols. When markets are buoyant, all is well. A company like Celsius can even make huge gains.
But it's when prices fall sharply that things go wrong... Because Celsius and the other staking and lendig platforms are exposing themselves to a liquidation of the cryptos placed as collateral, in other words the sale of their customers' cryptos! So, unless they add liquidity (additional bitcoins in our example), their assets placed as collateral are automatically sold. And not necessarily at the best price. 😅
The problem is that, at that point, customers want their cryptos back. That's what happened with Celsius, which found itself in the untenable position of returning bitcoins to its customers while trying to deploy more capital so that its positions weren't liquidated. In the impasse, the company therefore decided to freeze all operations.
What's wrong with stETH?
Analysts also discovered that Celsius had converted a significant proportion of its assets under management into stETH (409.260 units, or $447 million).
The stETH is a token that you receive from the company Lido when you deposit ETH (ether) via its services in the Ethereum 2.0 staking system. It is the guarantee that you will be able to unlock your ETH once the update has been implemented (because they are immobilised until this stage). Its value is 1:1 with ETH. To put it simply, it's like a document certifying that you'll get your house back once it's been renovated.
This is very handy for Celsius, as it allows them to continue speculating based on the derivative of an asset they no longer fully own.
The problem is that stETH has lost its anchor to ETH in recent days. At the time of writing, it is worth 5% less than ether, not least because of the further postponement of the Ethereum 2.0 update and some investors' need for liquidity. Celsius could sell its stETHs at a loss, but this would be a very expensive operation.
Second major problem for Celsius: the company borrowed $308m in stablecoins on Aave by depositing stETH as collateral. If the loss of the anchor worsens, the company is exposed to margin calls (the obligation to increase the level of its collateral) to avoid liquidating its stETH.
Does Celsius have any other debts?
According to CoinMetrics, the company controls the largest vault of WBTC (bitcoins 'wrapped' on Ethereum) in the MakerDAO protocol. As of 15 June, it had placed 24,000 bitcoins as collateral to obtain DAI stablecoin. The problem is that the bitcoin price is continuing to fall, so Celsius is exposed to liquidations if the downturn continues. To postpone the fateful moment, the company has already injected new liquidity. The threshold at which its bitcoins will automatically be sold has fallen to $14,000.
At this level, Alex Mashinsky and his teams, who have since called in the bank Citigroup to make progress on its restructuring, have given themselves some oxygen. But liquidation levels are public and some opportunistic speculators could be tempted to push prices down to force Celsius to sell its assets...
Does Celsius have a history of mismanagement?
The company hit a rough patch last year with the loss of 900 bitcoins (currently $20 million) it had deposited within the Badger DAO protocol, which fell victim to a hack. Celsius is also said to be the holder of large quantities of stETH (around 35,000, currently $42 million) issued by another company, StakeHound, which disappeared after losing the private keys to the underlying ETHs...
What future for the company and user funds?
There are no 36 solutions. To survive, Celsius needs money, either via a loan, a capital increase or a buyout. But the first option seems unlikely given the platform's insolvency. That leaves a capital increase or a buyout. "A player with solid foundations could take over the business by paying customer withdrawals in ETH, before exchanging the stEHT held by Celsius for ETH between now and the migration to Ethereum 2.0," explains Charlie Meraud, head of Woorton. "But we would still have to advance several billion dollars and that's subject to there being no other corpses in the wardrobe," adds the expert.
What about customers? Under Celsius' terms of use, the company reserves the right to deduct from its users' deposits. In other words, nothing is guaranteed.
Are other companies threatened by this contagion?
Celsius is the first victim of Terra's fall and the downturn in the markets, but other players also seem to be very exposed.
According to the US media outlet The Block, the fund Three Arrows Capital (3AC) has suffered more than $400 million in liquidations and is reportedly working on a solution to reimburse its investors. The recent events would be just more bad news, following massive investments by the fund in projects such as Avalanche, Polkadot and Ethereum, which have fallen by 57%, 40% and 47% respectively over the past 30 days.
Knowing Three Arrows Capital's positions, other funds may be tempted to speculate on the downside to eliminate a competitor.
Is this the end of DeFi?
Paradoxically, these events are all arguments in favour of decentralised finance, which is transparent by nature. The companies affected by the crisis are the centralised finance companies (CeFi) that conceal their investment strategies from their users. Celsius would certainly not have had its success if the platform had communicated its methods for offering up to 20% returns.
DeFi's protocols make it possible to trace what is being done with funds at any time, offering anyone the opportunity to arbitrate according to their risk appetite. Future companies that build applications using these and revealing their strategies in real time will enjoy a competitive advantage.
