Disgraced cryptocurrency lender Celsius Network asked a court this month to return assets to its “custody clients,” but not to its “earn-and-borrow” c
Disgraced cryptocurrency lender Celsius Network asked a court this month to return assets to its “custody clients,” but not to its “earn-and-borrow” customers. Wondering how to keep yourself in the former group when the crypto exchange you’re using goes under? Here’s a summary.
What exactly is a “custody client?” It’s similar in principle to a savings account with a traditional bank — often repayable upon demand by the custodian. In this case, it’s Celsius that has a fiduciary responsibility.
This type of account is kept separate from an “earn-and-borrow” account. It includes coins that can be transferred, swapped or used as loan collateral, but they don’t earn rewards. Purchased or transferred coins will go to your custody account. It is estimated Celsius has approximately 74,000 custodian accounts.
Related: Celsius, 3AC demonstrated why more financial activity needs to be on-chain
In contrast, coins in your earn-and-borrow account will earn rewards but can’t be swapped or used as loan collateral. This applies to stakers and — obviously — borrowers.
The bankruptcy court has scheduled a hearing for Oct. 6. The argument Celsius put forward is that custody clients retained “beneficial ownership” of their coins, so they don’t form part of Celsius’ bankruptcy estate.
Celsius follows Voyager Digital and Hodlnaut, which, on Aug. 29, were put under interim judicial management — “intensive care” in insolvency speak. And they will not, in my view, be the last during this crypto winter. Crypto carnage is underway, but the question is: What key lessons can be learned from Celsius’ downfall? Are your coins at risk of being placed in the “wrong kind of account” in the future? Let’s examine.
Related: Hodlnaut cuts 80% of staff, applies for Singapore judicial management
Celsius, founded in the United States in 2017, claimed to have 2 million users across the world as of June 2022. It had raised substantial sums from investors, estimated at $750 million as of late 2021. The company’s business model drew some parallels to a traditional bank — using the concept of fractional reserving — receiving deposits from crypto investors searching for a yield and, subsequently, providing loans to earn a margin, profits if you like. But what factors and events possibly contributed to Celsius’ demise into its unenviable position — the insolvency abyss?
Firstly, it seems as though Celsius’ strategy relied upon a continuous bull market to keep liquidity flowing — more new users depositing on the platform to satisfy the rewards and withdrawals of existing users. A Ponzi-type structure? Perhaps. A strategy orchestrated by leadership — most definitely. They decided to bet on either black or red, compounded by overall poor investment decisions. According to numerous sources, Celsius CEO Alex Mashinsky took control of Celsius’ trading strategy only a few months before its demise, often overruling experienced investment managers.
Related: Celsius CEO personally directed crypto trades months before bankruptcy
In addition, it often positioned itself as a high annual percentage yield (APY) provider relative to other decentralized finance (DeFi) platforms — particularly, its CEL tokens, where returns of 20% were being offered. This raises the question as to whether such rates were sustainable in a cyclical downturn. When lending out depositors’ crypto, it seems the risk profile of these borrowers was high — high in reference to credit and default risk. Traditional banks have had decades of experience and data to draw upon and refine their credit risk procedures before lending. I doubt Celsius had the same depth of expertise.
And then came the liquidity crunch came — similar to the run on the Northern Rock bank in the United Kingdom back in the 2008 financial crisis. Because of the concept of fractional reserving, no bank or lending institute is able to simultaneously satisfy withdrawal demands if a proportion of depositors all come calling at once. Celsius recognized this and thus froze withdrawals and trading activity as soon as the alarm bells rang.
On balance, whatever its fate, Celsius has contributed to the development and evolution of crypto and DeFi, akin to inventors whose ingenious inventions just fell short of commercial success. They played a vital role in the process and allowed others to succeed. Valuable lessons can be learned, and the teachings applied.
Related: Sen. Lummis: My proposal with Sen. Gillibrand empowers the SEC to protect consumers
Further mitigating factors reside in a series of crypto events — Terra’s LUNA Classic (LUNC) and TerraClassicUSD (USTC) crash and the BadgerDAO hack. Celsius had exposure to both, which culminated in a financial impact that punched holes in its balance sheet. Macroeconomic events of rising global inflation no doubt played a part. With a glut of “new…
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