A stark reminder of “not your keys, not your coins”
It’s been barely a month since the collapse of Terra’s stablecoin, whose sister protocol Anchor promised a never-ending 20% yield per year. Within days, Terra’s collapse wiped $18b out of the stablecoin market and put the rest of the crypto market into a tailspin. Now one month later, after another drop in the market, some participants are struggling to stay afloat. In particular, the lending company Celsius Network halted withdrawals of user funds, locking in place over $10b of customer assets.
Celsius’ behavior highlights the risks of centralized finance (CeFi) providers chasing yield
Whereas Celsius began as a traditional middleman between borrowers and lenders, in the past year it became something more akin to a hedge fund — one which is now struggling to manage leverage and remain solvent.
In their quest to find higher yields, Celsius used client money in ways that were not transparent and increasingly risky. Legally, they had the right to do so: their terms of use reserve the right to rehypothecate customer assets, and users have no insurance including in the case that Celsius goes bankrupt. Users have no rights of control over the business activities of Celsius and thus the use of their assets.
Depending on custody and the protocols, DeFi is often a safer option than CeFi counterparts
In a post-2008 world where all financial companies are assumed to be closely monitored by regulators, the harsh reality is that many crypto companies still operate in very loose regulatory environments. Regulators need time to come to terms with the new technology, but this hasn’t stopped entrepreneurs from plowing ahead and building useful products and services to boost crypto’s adoption. Whether it be Charlie Shrem’s BitInstant, Mark Karpelès’ Mt. Gox, or Arthur Hayes’ BitMEX, this industry’s history is marked by entrepreneurs unafraid to blaze the trail with little to no regulatory guidelines.
As many early crypto users learned, however, relying on centralized companies for services has its own risks. Following the demise of the early Bitcoin exchange Mt.Gox, many users switched to the peer-to-peer marketplace LocalBitcoins. Following mounting issues on the early derivatives exchange BitMEX, many traders migrated to the decentralized exchange dYdX. And now, many Celsius users will likely come away from the experience questioning the wisdom of turning over their crypto assets to a centralized lender.
Once withdrawals are re-enabled, it’s easy to imagine Celsius users flocking to decentralized finance (DeFi) protocols like Aave and Compound, which offer an automated lending and borrowing service directly on the blockchain. Their source code is freely available to view, both have undergone multiple external audits, and the assets within each protocol are visible on-chain to everyone, in real time. These are the new financial rails of the internet, where users interact directly with one another without reliance on people or companies, but it will take time for the merits of DeFi over centralized finance (CeFi) to be widely understood.
DeFi safety depends on keeping private keys safe, and wisely choosing protocols
Users of centralized platforms often enjoy a polished user experience, but will always be at risk of losing access to their assets due to overloaded servers, company bankruptcy, or even theft by rogue employees. In DeFi, by comparison, the safety of users’ assets hinges on only two things: the safe custody of private keys, and the safety of the DeFi protocols being used.
Unstoppable Finance aims to solve both problems, helping users to keep their private key safe, and use only the safest protocols. Our users retain control of their private keys but have the option to back them up in the cloud to protect against accidental loss. We also do the work of determining which DeFi protocols present legitimate long-term yield opportunities and are safe to use, before presenting them in the app. In this way, we enable crypto users to begin owning and controlling their assets directly.
When did Celsius start to go off the rails? What were the signs?
In 2021 Celsius Network grew to over $20b in assets and raised $750m of funding. Then, their CFO was arrested in connection with a fraud investigation at a previous employer. In December, Celsius absorbed a $51m loss during the hack of the BadgerDAO, leaving users wondering what a lender like Celsius was doing on a DeFi yield aggregator protocol. In April of 2022, Celsius stopped taking deposits from US non-accredited investors amid mounting regulatory pressure, which saw competitor BlockFi pay a $100m settlement to the SEC two months prior.
Then came the Terra collapse in early May 2022. Celsius users began to complain about difficulty withdrawing their assets, as Celsius secretly scrambled to withdraw $463m from Terra’s collapsing Anchor protocol. Their exposure was never publicly stated, but was laid bare by a report from blockchain data analytics firm Nansen. Celsius had avoided the worst of the Terra crisis, but now people were asking questions. Why did Celsius have such a massive exposure to Anchor? How much of their yield was coming from their own lending operations, versus elsewhere in the DeFi market?
Ambitious Celsius painted themselves into a corner by locking $500m of stETH on MakerDAO
On Sunday June 12th, a month after the Terra crisis and amid another crypto market downturn, Celsius suspended customers’ ability to withdraw funds, once again failing to communicate what was going on behind the scenes. By again investigating Celsius’ blockchain wallets, the public discovered that Celsius was struggling to provide more collateral to MakerDAO — a DeFi protocol enabling the creation of up to $50 worth of DAI stablecoins for every $100 of crypto deposited. With over $500m of collateral locked, Celsius had leveraged themselves to the tune of $200m.
The real problem lies in Celsius’ choice of collateral. Always hungry for extra yield, Celsius used “staked Ethereum” (stETH) tokens, which represents a “liquid” (sell-able) staked Ethereum. But when Ethereum fell by more than 35% in the days previous, Celsius found their collateral approaching liquidation, and discovered that the market for stETH was too illiquid for the unwinding of a $500m position. Hence Celsius paused customer withdrawals, in order to avoid a failure to pay out in a bank-run type scenario.
With the crypto market hoping for the best but assuming the worst, Celsius’ competitor Nexo on Monday publicly made an offer to purchase all of Celsius’ assets. As of the time of writing, Celsius is likely still unwinding their stETH position, as evidenced by and the increasing discount of stETH in the market. (Currently 5% below the price of ETH, despite its 1:1 backing.)
Well intentioned CeFi companies can lose their way, there is no substitute for DeFi’s trustlessness
Despite adopting the crypto-native values of independence from banks and Wall Street, Celsius eventually lost their way in their ambition to deliver unsustainably high yields to customers. Those customers have now learned that trusting an organization with funds can turn out to be a grave mistake, especially in crypto’s wild west.
Ironically, the Celsius example also demonstrated the radical transparency of blockchains and DeFi protocols: Celsius’ on-chain positions and transactions are completely observable by external on-lookers, with nothing staying in the dark. Should they become truly insolvent, the DeFi protocols that Celsius used for leverage will automatically liquidate their collateral and return it to lenders.
At Unstoppable Finance, we recognize that these protocols are the future of finance, and we’re committed to building a wallet which will serve as the access layer for users. At no point will we have custody or control over our customers’ assets, always staying true to the core principle of decentralized finance: your keys, your coins. By building a seamless user experience and presenting only the safest and most useful DeFi protocols, the bank of tomorrow will be in your hands.
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