The Celsius Deception

Crypto shadow banks: the betrayal of everything crypto.

In 1993, WIRED’s Crypto Rebels article introduced cypherpunks to the world. This mix of coders, libertarians and millionaire hackers were fighting for something big: “At stake: Whether privacy will exist in the 21st century.”

Tim May had previously set out their values in his Crypto Anarchist Manifesto:

“Just as the technology of printing altered and reduced the power of medieval guilds and the social power structure, so too will cryptologic methods fundamentally alter the nature of corporations and of government interference in economic transactions.”

To WIRED, the ultimate crypto tool would be “anonymous digital money.”

This tool was finally realized on 3 January 2009 when the Bitcoin network was born. In describing it as “peer-to-peer” in the whitepaper and including the reference to “Chancellor on brink of second bailout for banks” in the genesis block, creator Satoshi Nakamoto differentiated between two diametrically opposed systems: crypto and banking.

Banking and crypto systems explained

Both systems are just databases.

Each bank has their own private database, which is really simply a list of what they own and what they owe to others. Only the individual bank knows what is inside their database.

Crypto is a public database, which means it is transparent, global and open to everyone. The internet enabled us to copy and share information anywhere, driving publication costs to near zero, and disrupted centralized industries like media, music, etc. Crypto is essentially the internet, but for money. Rather than allowing cost-free copying (bad for money), crypto enabled us to store value digitally in a public database. It also allows us a unique opportunity: the chance to have an ownership share in this internet of money.

Here is a simple summary of banking and crypto.

These two systems are about more than value, however; they are also about our values.

At the heart of the banking system are three fundamental lies, set out below.

1. It’s your money. The bank will tell you that the money you deposit belongs to you. In fact, legally the money becomes the property of the bank. In law, you are an unsecured creditor to them. In return, the bank gives you an IOU, called a deposit account.
2. You know where your money is. The bank will tell you that “your” money is safely held at the bank. In fact, the bank holds only a fraction and then can do whatever it wants with the rest. If you want more than this fraction of your money back, the bank takes it from somewhere else.
3. Your money is safe. The bank will tell you that your funds are “insured” by the government, up to a certain amount. In fact, there is no government insurance fund that corresponds to these deposit amounts. It isn’t insurance; it is a government undertaking, in a failure situation, to print more money to give to the banks so that they can repay their liability to you.

The crypto system is completely different. You hold the keys to your money, you decide how your money is used, and the purchasing power of your money is insured by objective code rather than government promises.

How Celsius operated

In financial terms, Celsius operated exactly like a traditional bank. Celsius, and many others, are essentially crypto shadow banks. Here is a simple test to see if you are dealing with a bank or a crypto entity.

Actually, Celsius was a lot worse than a bank because it misled people into thinking they used the crypto model.

Here is how they sold who they were:

“We believe in a new economy. Where ethical behavior is the baseline, and where everyone — and we mean everyone — has the opportunity to succeed financially. With a little bit of humanity and honesty, and the power of a digital currency that’s as strong as it is accessible, we’re ushering in the new economy today.”

“Join us for military-grade security, next-level transparency ….”

“Get Celsius.

Unbank yourself.

Earn high.

Borrow low.

Change the world.”

They misled many into believing that they were pursuing the better values espoused by the crypto movement. It seems clear that many people took risks with Celsius that they didn’t know they were taking.

In reality, Celsius operated like a wolf in sheep’s clothing.

Where does interest come from in crypto?

To understand the Celsius failure and crypto shadow banking, you need to know where interest comes from in traditional finance and crypto.

Just because you put a stupid business model on-chain doesn’t make it better. Interest needs to come from real economic activity.

Why Celsius failed

Celsius failed the way all banks fail, set out in the equation below:

Failure formula = Unrealistic business model + maturity mismatch + leverage

Here is a quick explainer:

Another important thing to know is that there is always a trigger for bank runs, based on variance in the business cycle. Essentially, businesses with volatile revenues and fixed costs are the first to be exposed as swimming naked when the tide goes out: their business model can’t survive through different economic cycles.

What makes the above formula worse is a fourth element:

+ misleading depositors

Crypto shadow banks all have this messaging in common: banks are evil. Then, they do exactly the same thing. But worse, because it is much more speculative.

The crypto shadow banking business model isn’t likely to get anyone a boat, except bank management.

In Celsius’ case, the following actions contributed to their failure:

• They locked-up users’ money in staked ETH on Lido, so there were not enough liquid funds to cover redemptions.
• They lost millions in amateurish mistakes and hacks, including on StakeHound and Badger DAO.

In addition, their wallet 0x4b5 … 81c withdrew significant funds from Anchor protocol on Terra just before the collapse.

The fact that Celsius were speculating with client funds in such obvious Ponzi schemes and wildly degen protocols is stunning and says everything you need to know about their unrealistic business model. It is doubtful that users who bought into their “new economy” “unbank yourself” “military-grade security” marketing knew that this is what they were getting into.

There is an important lesson here: the failure number is somewhere between 1 and 100. Think of it as a line of people who want their money back. For well-run banks without much maturity mismatch and lots of liquidity, the number is closer to 90. The first 90 people in line get their money back. For badly managed banks, like Celsuis, the number is maybe 50. Some estimates showed that only 27% of their ETH position is liquid, plus presumably they have other cash on hand. But, actually, no one has any idea. Banks are black boxes and outsiders don’t have any idea of what really lurks in their internal database.

The best way to stave off a bank run is to convey confidence, so people don’t ask for their money back. That is exactly what Celsius founder Alex Mashinsky did the day before Celsius froze withdrawals and effectively failed. Questioned on Twitter by Mike Dudas, an investigative reporter at The Block, Mashinsky tweeted “do you know even one person who has a problem withdrawing from Celsius?” and chided him that “our job is to fight Tradfi together.”

Who else will fail?

All crypto shadow banks are business models built on sand. They are all subject to bank runs in times of market dislocation.

Want to spot the next Celsius? Simple, just use the failure formula above.

From my own impressions, based on a financial perspective, here are 6 crypto shadow banks that are likely insolvent right now and will probably fail.

1. BlockFi
2. Crypto.com
3. Swissborg
4. Vires Finance
5. Voyager
6. Maple Finance

Pro tip: get your money out of all of them before others take out their funds or you might be left with nothing.

When looking for failure in waiting, make sure that you include the fourth element as well: does the firm seem to be misleading depositors?

I haven’t looked into it deeply, but take the Bulgarian company Nexo as an example. They often talk about insurance, like this sponsored post: “We recently increased our total insurance on custodial assets to $775 million.” However, when you get into the details they don’t seem to have any insurance of their own at all. They have business agreements in place with other companies, such as custodians like BitGo. These custodians have insurance, but not Nexo; Nexo do not seem to be named as the Loss Payee on the policy. Almost anyone can sign these custodial agreements. At the very least, it seems Nexo is misleading potential users, just like Celsius did.

Another Pro tip: get your money out of any front-end “wrapper” wallet that was ever associated with Anchor. If you get fooled twice, shame on you.

Tether

There is one thing in crypto that makes crypto shadow banks look like they are perfectly respectable: Tether.

Tether is a crypto unit issued by iFinex Inc. and affiliated companies in the British Virgin Islands and the Seychelles that is marketed as being redeemable for a US dollar.

That iFinex operates based on a banking model and does not have cash sufficient reserves to back Tether is not in dispute. The New York Attorney General stated that “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie” and noted they “obscured the true risk investors faced and were operated by unlicensed and unregulated individuals and entities dealing in the darkest corners of the financial system.”

iFinex admitted in 2021 that that less than 76% of Tether’s reserves were held in cash or cash equivalents. Actual cash backing was only 3% (the rest were cash equivalents, the kind of financial instrument that freezes up in times of crisis). In the CFTC’s order against iFinex they found that there was sufficient backing for Tether only 27.6% of the time examined.

So, technically, Tether’s failure number is maybe somewhere between 28 and 76. This isn’t a problem until you are person number 77 in line to get your money. Then “withdrawals are paused”, confidence collapses, and there is a bank run. Your holdings will probably go to around zero.

What is stunning about the Tether deception is that it makes up almost half of all crypto stablecoins, much larger than Terra. When its house collapses, great will be its fall, potentially destabilizing the entire crypto ecosystem.

Another Pro tip: sometimes fraud hides in plain sight, like Terra or Celsius. Tether is for sure a fraud and another betrayal of crypto. Don’t get caught holding it when the music stops.

Predictions

Here are some predictions and implications about crypto.

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