Hands of a guy on laptop keyboard

The collapse of crypto market rings the bell for regulators

17 June 2022

How fast do we need regulation for bridging crypto and traditional finance?
Hint: Right now.

Celsius Network: A case study

Crypto markets are again being shaken by the recent news (or lack of it) from the cryptocurrency project Celsius Network. Fear is growing within the community that Celsius is currently balance-sheet insolvent. Similar effects caused the rapid price drop of the Terra cryptocurrency only a month ago, bottoming out around $50 billion in market value. The investor-driven run to salvage their funds caused the Celsius Network to temporarily halt withdrawals and the use of the network. In a message posted on their website Celsius stated:

‘Due to extreme market conditions, today we are announcing that Celsius is pausing all withdrawals, Swap, and transfers between accounts. We are taking this action today to put Celsius in a better position to honor, over time, its withdrawal obligations’.

This was not taken lightly by the Celsius community, which has a strong voice on Twitter, as happens when cryptocurrencies are in the news. The founder and CEO of Celsius Network, Alex Mashinsky, is unavailable for comments for a couple of days. Mashinsky is the US entrepreneur who, in the early 1990s, founded VoiceSmart, one of the first companies to offer computer-based VOIP phone service.

Why is Celsius Network so important?

The possible collapse of Celsius might inflict deep wounds on the crypto industry because Celsius is one of the largest investment bridges from venture capitalists and retail investors to the cryptocurrency market. The Celsius project raised $864 million in venture capital and has more than 1.5 million users. At one point, it custodied more than US$ 3 billion, serving as a de-facto custodial asset manager. 

As part of their service, the Celsius platform offered its customers cryptocurrency trading, cryptocurrency landing, and high yield deposits on stablecoins. The Celsius Network promoted crypto loans and stablecoin yields using videos such as: ‘How a Celsius loan got my family out of Ukraine‘, or ‘Yield: The future of FinTech’. Celsius is advertised as a Centralised Finance (CeFi) application. CeFi solutions bring the benefits of stablecoin yields and crypto trading, but with the security measures used in traditional finance for loans, deposits, and asset management.

The Celsius Network is, in essence, a crypto industry product. They introduced themselves with the Celsius Whitepaper, and issued Cel tokens, which serve as a loyalty reward mechanism within the system.

 

How CEL tokens form Celsius Network works

Illustration: ‘How CEL works – The Celsius flywheel. Source: Celsius Network

 

How did it happen?

Since Celsius was not obliged to show its investment positions as traditional asset management companies must, it started investing in the highly leveraged loans using decentralised protocols for liquidity such as the Lido protocol. Celsius also took loans using other protocols such as Aave, MakerDAO, and Compound. These are algorithmic, autonomous, interest rate protocols, and since they are open-source, Celsius actually acquired billions in combined liabilities across multiple assets and protocols. Lending on decentralised money markets is protected by the mechanism of the lower margin. When the price reaches the lower bar, the loan is automatically liquidated against the borrower to reduce the possible insolvency. 

The Lido Finance protocol allows any user to earn ethereum cryptocurrency by staking yields without running a staking infrastructure. Looking to borrow even more, Celsius locked a significant allocation of these funds in smart contracts. This means they cannot be accessed as collateral for the debt for at least one year. 

This is not the end

This whole situation could even be considered a ‘market mistake’ by greedy fund managers, but to make things worse (and completely irresponsible) the Celsius Network is actually lending more money right now, with the small number of liquid funds it has left, betting total bankruptcy on a risky gambling call. Indeed, to at least try to recover their previous state, Celsius needs to ensure its own liquidity first, but this move is dangerous. 

This scenario renders a starkly grim prospect for Celsius, but also for the entire crypto market. It will certainly create much larger losses and maybe even a rushed reaction by authorities. The company needs to be more transparent about what’s currently going on, and what steps are being taken. This irresponsible behaviour towards their customers (investors) is why restrictive policies are often championed when discussing crypto markets. Regulators need to admit that online and digital finance, in all of its forms, should be under the same customer protection regime as traditional finance. That will remove, or at least decrease this grey area of unregulated projects that benefit from the lack of digital asset regulation but utilise the purchasing power of investors from regulated markets. Rules and audits are necessary for transparency and security.

Close call for Celsius Network

The spillover of the possible loss might endanger both markets (crypto and traditional) since they are now more dependent on each other. Analyzing the latest reports from markets, it looks like this gambling move from Celsius Network actually worked out (in a short term). Celsius will pull out of this, but a risky gambling strategy like this usually ends in a crash. The crash which we didn’t wait for long to see. Major crypto hedge fund Three Arrows Capital, which managed around $1 billion, failed to meet margin calls and was liquidated by crypto lenders. Collapse of the Three Arrows Capital might be the start of a big crypto purge which will leave ‘alive’ only the fittest.

0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published.

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

Subscribe to Diplo's Blog