Disgraced cryptocurrency lender Celsius Network asked a court this month to return assets to its “custody clients”, but not to its “earn and borrow” clients. Wondering how to stay in the old band when the crypto exchange you use goes down? Here is a summary.
What exactly is an “on-call client”? It is similar in principle to a savings account with a traditional bank, often redeemable at the request of the depositary. In this case, Celsius has a fiduciary responsibility.
This type of account is separate from an “earn and borrow” account. It includes coins that can be transferred, traded, or used as loan collateral, but they do not earn rewards. Coins purchased or transferred will go to your trading account. Celsius is estimated to have around 74,000 custodial accounts.
In contrast, coins in your earn and borrow account will earn rewards but cannot be traded or used as loan collateral. This applies to stakers and, of course, to borrowers.
The bankruptcy court has scheduled a hearing for October 6. Celsius’ argument is that the depositary customers retained “beneficial ownership” of their coins, so they are not part of Celsius’ bankruptcy.
Celsius follows digital travel and Hodlnaut, who, on August 29, were placed under provisional judicial management — “intensive care” in insolvency matters. And they will not, in my opinion, be the last during this crypto winter. The crypto carnage is ongoing, but the question is: What key lessons can we learn from the drop in Celsius? Are your coins at risk of being placed on the “wrong type of account” in the future? Let’s examine.
Celsius, founded in the United States in 2017, claimed to have 2 million users worldwide as of June 2022. It had raised substantial sums from investors, estimated at 750 million dollars at the end of 2021. The company’s business model has drawn parallels with a traditional bank – using the concept of split booking – receiving deposits from crypto investors looking for a return and subsequently granting loans to earn margin. , profits if you wish. But what factors and events may have contributed to Celsius’ demise in its unenviable position – the abyss of insolvency?
First, it seems that Celsius’ strategy relied on a continuous bull market to maintain liquidity – more new users depositing on the platform to satisfy rewards and withdrawals from existing users. A Ponzi-like structure? Maybe. A strategy orchestrated by leadership—surely. They decided to bet on black or red, compounded by bad investment decisions. According to multiple sources, Celsius CEO Alex Mashinsky took control of Celsius’ trading strategy just months before its demise, often wiping out experienced investment managers.
Also, it has often positioned itself as a high Annual Percentage Yield (APY) provider compared to other decentralized finance (DeFi) platforms – particularly its CEL tokens, where 20% yields were offered. This raises the question of whether these rates were sustainable in the face of a cyclical downturn. When lending crypto to depositors, it appears that the risk profile of these borrowers was high – high in reference to credit and default risk. Traditional banks have decades of experience and data to draw upon to refine their credit risk procedures before lending. I doubt Celsius has the same depth of expertise.
And then came the liquidity crunch – similar to the run on Northern Rock bank in the UK during the 2008 financial crisis. Due to the concept of split provisioning, no bank or credit institution is able to satisfy withdrawal requests simultaneously if some of the depositors all call at the same time. Celsius recognized this and therefore froze withdrawals and trading activity as soon as the alarm bells rang.
Overall, regardless of his fate, Celsius contributed to the development and evolution of crypto and DeFi, akin to inventors whose ingenious inventions failed to find commercial success. They played a vital role in the process and enabled others to succeed. Valuable lessons can be learned and lessons applied.
Other mitigating factors lie in a series of crypto events – Terra’s LUNA Classic (LUC) and TerraClassicUSD (USTC) crash and the BadgerDAO hack. Celsius was exposed to both, resulting in a financial impact that punched holes in its balance sheet. Macroeconomic events related to rising global inflation undoubtedly played a role. With a glut of ‘new money’ being printed by governments during the pandemic, its increasing speed through the system coupled with supply chain issues has only added more fuel to the bubble and collapse. crypto speculation.
So what are the three main lessons that can be learned from the plight of Celsius?
First of all, whether you hold a deposit account or an earn and borrow account will depend on the facts – it is not a matter of choice. While this almost certainly comes down to a legal determination, in my view the economic substance of your business should be taken into account. Even then, I suspect Celsius will argue for a narrow definition of “custody” in this context, and don’t be surprised if there are clawback clauses. They have openly declared their intention to file a plan that will offer customers the option of staying crypto for a long time.
Second, it’s become a bit of a cliché, but the “not your keys, not your coins” mantra rings true. The risks of custodial portfolios are now apparent. Investors whose crypto is locked to a platform are more likely to suffer losses. Under insolvency laws, investors are classified as unsecured creditors, and even if they are a custodial client, they are likely to receive a fraction – if any – of the value of their portfolio. .
Finally, if an APY reward is too good to be true, it might be. In the case of Celsius, the problem was compounded by the offer of near-zero loan interest rates of 0.1% APY. Simple math suggests that his business model was not robust at all.
Only time will tell what will emerge from the rubble of this catastrophe. If history is to teach us anything, it’s that bear markets are often the catalyst for the focus on innovation and utility – the era of Web 1.0 and 2.0 dot.com is testament to this. Consolidation, mergers and acquisitions are definitely on the horizon, and with them will emerge the new Amazon and eBay of the cryptoverse.
Tony Dhanjal serves as head of tax strategy at Koinly and is its public relations and brand ambassador. He is a qualified accountant and tax professional with over 20 years’ experience across all sectors within FTSE100 companies and public practice.
This article is for general informational purposes and is not intended to be and should not be considered legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.