The Rise And Fall Of Celsius

Just as the dust had started to settle in the wake of the Terra LUNA bloodbath, another crypto scandal stepped into the spotlight to take its place. The rapid rise and fall of crypto lender Celsius has left everyone with some burning questions, most notably — what the hell happened and what can we do to make sure it never happens again?

What Is Celsius?

Celsius Network was founded in 2017 by CEO Alex Mashinsky, Daniel Leon, and Nuke Goldstein to facilitate banking services and transactions for the crypto space. But let’s get one thing clear, they are NOT a bank.

Instead, think of Celsius as centralized finance for the cryptocurrency world — where depositors are able to earn an interest on their deposits while borrowers can get crypto loans by paying a fee, similar to how you would with a bank. But Celsius was not regulated the same way traditional banks are.

The platform was marketed as offering “transparent and fair services” to the crypto community at large, as opposed to the traditional banking system.

How Did Celsius Gain Its Popularity?

The interest rates offered by Celsius were extremely high, in some cases as high as 18.63% APR. These were often paid in CEL tokens, the native token of Celsius Network.

While the rate for borrowing was extremely low, sometimes as low as 0.01% APR. These levels were rarely ever offered by banks, which is why people started taking notice of Celsius.

All things considered, Celsius seemed like it was backed by a group of promising entrepreneurs who were passionate about “unbanking” the world. Mashinsky himself had invested a sizeable chunk of his own money into Celsius and hosted weekly “Ask Mashinsky Anything” livestreams, supporting the company’s guise of maintaining transparency with their customers.

So, where did it all go so horribly wrong?

The Beginning Of The End

Stakehound (an Ether 2.0 pledge solution) announced in June 2021 that it had lost over 38,000 $ETH of private keys deposited on behalf of its customers, the majority of which is believed to have belonged to Celsius. At today’s $ETH price, this loss amounted to approximately USD 47.3 million, representing the first crack in Celsius’ foundation.

Other issues started to come to light following this, such as the arrest of Yaron Shalem (CFO of Celsius) in November 2021 due to money laundering concerns. In December 2021, Celsius was reportedly affected by the BadgerDAO exploit where hackers stole hundreds of millions from users. Celsius reportedly lost USD 54 million from this.

By the time April rolled around, Celsius users started cashing out as the market took a downturn and the value of crypto in Celsius’ custody had collapsed. Celsius users also started leveraging their low interest loans for debt relief and at this point it became clear that Celsius was not stringently vetting their borrowers.

Sealing The Deal

The final blow to Celsius came with the Terra LUNA crash. Centralized firms like Voyager and Three Arrows Capital filed for bankruptcy and rumors of Celsius being secretly insolvent began to spread. This lead to billions of dollars in outflow from Celsius.

Finally, Celsius froze all customer withdrawals and transactions on 12 June and proceeded to file for bankruptcy the next month.

Underlying Cracks

On the surface, it seemed like Celsius only started having problems in 2021. But a deeper dive shows that Celsius was doomed from the start, from its inadequate risk management to its alleged market manipulation.

According to Celsius’ former director of financial crimes compliance, Timothy Cradle, the company did not prioritize risk management much. For instance, a former senior member of the human resources team said that they were specifically told not to run a background check on former disgraced CFO Yaron Shalem before he joined the company. Cradle also mentioned that resources for the risk management team were limited and between 3 full-time employees, they could not cope with the rapid expansion of the platform.

Speaking of growing too fast too quickly, this was another big reason why Celsius eventually failed. In a desperate attempt to keep up with its rapid growth, Celsius started making riskier choices like investing in high risk cryptocurrency projects and hedge funds without conducting proper due diligence. This started a vicious cycle of the company entering dangerous levels of overleveraging and partial capitalization.

There were also claims made by former Celsius employees that the company had artificially inflated its CEL token. Arkham, a blockchain data firm, estimated that Celsius had spent $350 million acquiring CEL tokens on exchanges over the years. Arkham also estimated that accounts related to Mashinsky appeared to have sold or swapped $40 million worth of the CEL tokens.

So, What Can We Learn From This?

If something sounds like it’s too good to be true, it probably is. The Celsius model — offering extremely high interest rates for depositors and charging extremely low interest rates to borrowers — did not come without high risk. Celsius heavily downplayed that risk to its customers, which ended in them dragging down their innocent consumers along with them.

Celsius also offered these interest rates during a crypto bull market which, as we’ve seen, were clearly unsustainable during a cyclical downturn. Combine this impossible business model with a lack of financial and risk management expertise and you have a recipe for disaster. A true testament to a company’s resilience and trustworthiness is if they are able to survive a bear market and come back stronger from it.

“Not your keys, not your crypto”

The Celsius disaster has been described as the “Lehman Brothers” episode of the crypto community and as we learned back then, decentralization is a necessity. There is an obvious risk with custodial wallets — if you keep your crypto on a platform instead of a wallet, there’s a higher chance of you suffering losses. As a rule of thumb, just remember this: “not your keys, not your crypto”.

Looking into the future, we’re likely to see a regulatory crackdown on the industry as the market becomes increasingly populated with high risk instruments and retail investors. Until then, we will probably see other meltdowns in the industry this crypto winter.

If you enjoyed reading this, stay tuned for my next article where I take a closer look at the FTX debacle.

Disclaimer: Any expression of opinion (which may be subject to change without notice) is personal to me (the author) and I (the author) make no guarantee of the accuracy or completeness of any information or analysis supplied.

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