source: blog.celsius.network
On Sunday 13th of June, Celsius Network announced they were halting all withdrawals, transfers, and asset swaps on the platform. The reasons given were "extreme market conditions" and to put Celsius in a "better position" to honor, over time, its withdrawal obligations. Celsius users have reacted with panic and outrage, which is understandable given that many have invested their whole life savings into Celsius.
Previously, Celsius offered yields on crypto, as well as the ability to borrow against crypto holdings to their million-plus users. The goal was simple: disrupt the financial industry and introduce financial freedom through crypto.
Image source: celsius.network
Celsius offered appealing yields. Their stablecoins, which are effectively cryptocurrencies tied one-to-one to fiat currencies, provided yields of up to 10%, with major cryptocurrencies like Bitcoin and Ethereum earned up to 8%.
But how? No detailed explanation or reports have ever been provided by Celsius, beyond its CEO Alex Mashinsky stating in several interviews that they generate revenue through "lending crypto" (such as Bitcoin or Ethereum) to credible institutions.
Celsius Network - What Happened?
It appears that at some point in the late fall of 2021, the dynamic of lending crypto to credible institutions with sound balance sheets has shifted to investing customers' crypto assets into increasingly exotic and risky instruments in order to earn yield for depositors.
December 2, 2021 - BadgerDao Hack
Celsius' problems date back to at least December 21 when BadgerDAO, a DeFi protocol for earning yield with tokenized Bitcoin on Ethereum, has fallen victim to an attack. An on-chain data suggested that Celsius Network may have been the biggest loser in the $120 million BadgerDAO hack.
The attacker drained 896.8 Wrapped Bitcoin worth just over $51 million at the time from an address commencing “0x534.” On-chain data suggests that this address was closely linked to Celsius Network, which saw that address transferring 125 ETH to another address commencing with “0xdb3” back in November 21. The “0xdb3” wallet held just under $68 million, of which $41.2 million was in Celsius’ CEL token. It also had multiple seven-figure transactions with one of Celsius' main wallets, which commences “0x4f6” and is labeled as “Celsius Network: Wallet 5” on Etherscan.
Furthermore, Celsius Network deleted questions related to the incident from its Reddit page, in order to keep "communities safe", when somebody posted rumours of the loss.
Image source: reddit.com
During the YouTube live stream AMA on 3rd December 2021, Celsius's CEO Alex Mashinsky confirmed that the company did indeed “lose money” in the BadgerDAO hack, but did not specify the exact amount lost.
9 May, 2022 - Terra's UST Collapse
In December 2021, blockchain analysis showed that Celsius made substantial deposits to Terra’s Anchor Protocol, which offered up to 20% returns on deposits of TerraUSD.
Wallets controlled by Celsius sent at least 261,000 ETH to Anchor Protocol over the past five months, according to analysis conducted by The Block Research, a blockchain analytics firm.
Image source: etherscan.io
Celsius's deposits began on December 19, with 146,000 ETH deposited through March 17. The pace then accelerated, with a further 115,000 ETH deposited between April 6th and May the 3rd.
We assume the strategy was to deposit bETH on Anchor protocol as collateral to borrow UST, and then deposit UST to Anchor for 19% yield.
However, on 11th of May, as TerraUSD collapsed, Celsius withdrew some 225,000 ETH (or $463 million) from Anchor Protocol, according to The Block Research’s analysis. The Block Research was unable to determine whether the remaining funds were withdrawn or written off, which would have been worth around $80 million at the time.
13th May, 2022 - Lido Finance Staked ETH Depeg
Perhaps the biggest misstep for Celsius was its decision to invest customers' ether tokens with Lido Finance.
Lido is a liquid staking solution for ETH 2.0, which lets users stake their ETH without locking assets or maintaining infrastructure. In essence users exchange their ETH to 'staked' ETH or stETH, with 1 stETH being equal to 1 ETH.
Celsius promised customers between 6% and 8% returns on ether deposits. It had at least $450 million in stETH in its primary DeFi wallet, but likely had more stored elsewhere, according to analytics firm Nansen, which tracks blockchain data.
On May 13th Lido sent out a tweet that the swap rate between ether (ETH) and stETH has deviated from its one-to-one peg amid crypto market turbulence, warning that while long-term stETH holders and liquidity providers are not at risk, leveraged positions on stETH are.
Image source: twitter.com
While one stETH is supposed to be redeemable for one ether, stETH's price has dropped compared to ether in recent weeks as the crypto market fall prompted holders to sell their stETH. That discrepancy has made it difficult for Celsius to convert its stETH back to ether to meet customer withdrawals.
With Celsius holding a large amount of stETH that was falling from its peg, illiquidity worries increased further, with the market to buy ETH for stETH not nearly liquid enough for Celsius’ large position to exit without sustaining substantial losses.
Furthermore, the slump in Bitcoin, which has shed about half its value this year, has also pressured Celsius. It pledged crypto assets pegged to bitcoin as collateral against a loan of other cryptocurrencies and as bitcoin fell, Celsius had to top up that collateral, according to analytics firm Nansen.
With an increasing number of users withdrawing their funds from the platform, and with cryptocurrency markets already selling off meaningfully over the weekend, Celsius announced they were pausing all withdrawals, swaps, and asset transfers on the platform.
Summary
The most serious issue with Celsius' operations was that it became increasingly clear that the company was taking enormous risks with the users' funds. On Tuesday the Wall Street Journal reported that Celsius have hired restructuring lawyers. Their terms and conditions explicitly state:
"In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations, any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws."
Whether they can resolve this will depend on the market conditions, luck, and time.
Ultimately Satoshi Nakamoto's vision of Bitcoin was an electronic payment system based on cryptographic proof instead of trust. Therefore, allowing a third party to store your private keys is against Bitcoin's ideals of monetary sovereignty.
A lesson may be drawn from this: not your keys, not your crypto.
DISCLAIMER: The information contained in this article is for educational purposes only and does not constitute any form of advice or recommendation by Wheatstones, and is not intended to be relied upon by users in making (or refraining from making) any investment decisions.