On June 13, a month after a stablecoin’s collapse sent the crypto market into a dive, crypto lender Celsius — known for offering investors up to 18.6% interest — halted withdrawals, helping make the dive a tailspin.
On Thursday (June 17) lender Babel Finance did the same, and staking and yield-farming platform Finblox limited withdrawals to $1,500 per month.
Which raises the question of what crypto lending really is, beyond the stated, “you give us money, we lend it to others for a fee, and pay you an interest rate ranging from excessive to outlandish.”
A look at what happened with Celsius provides an instructive peek inside the world of crypto lending and borrowing platforms, which migrated from decentralized finance (DeFi) to centralized (CeFi) firms like Celsius when the money started pouring in.
When venture capitalist Mike Dudas tweeted out a warning on June 11 that retail traders could lose money could lose money invested in Celsius, the lender’s CEO, Alex Mashinsky replied “Mike do you know even one person who has a problem withdrawing from Celsius? Why spread FUD [fear, uncertainty, doubt] and misinformation” before suggesting that Dudas was being paid to run down Celsius.
Mike do you know even one person who has a problem withdrawing from Celsius?,
why spread FUD and misinformation.
If you are paid for this then let everyone know you are picking sides otherwise our job is to fight Tradfi together…
— Alex Mashinsky (@Mashinsky) June 11, 2022
That was two days before Celsius stopped clients from withdrawing funds due to a liquidity crisis, citing “extreme market conditions.” Two days after that it hired restructuring lawyers.
What is Celsius?
Crypto owners have been bombarded with the message that they can put their crypto to work by investing it in these lending/borrowing platforms, with interest rates that can go from a couple of percent — still an order of magnitude over what banks will pay — to the near-20% rates available on Celsius, and even higher on other platforms, with different coins attracting different yields.
The process can seem bank-like — the returns are frequently compared to savings accounts’ interest rates — but there are a couple of key differences.
First, investors funds had to lock in funds, with a delay before they could be withdrawn.
Second, Celsius isn’t a bank. Mashinsky has been known to wear a T-shirt says “Banks are not your friend” when speaking at industry events.
That means lenders are in effect giving unsecured loans to a company with little regulatory oversight. And unlike registered brokerages, the funds are not protected from bankruptcy proceedings.
What Went Wrong
The basic premise is simple: Celsius pools investors funds and lends them out to people who put up their own crypto as collateral — the industry generally wants 125% to 150% to cover price fluctuations. Borrowers ranged from market makers to individuals buying a cryptocurrency in hope of paying the loan back and making a profit when the token’s price rises.
Read more: Latest Crypto Turmoil Could Signal the End of Sky-High DeFi Returns
Except that isn’t the only way Celsius made the return it needed to pay those rates and still make a profit. Among those were other risky but high-yield DeFi projects where the returns offers can be even higher — even “add a zero” higher — but can be dangerous.
See also: DeFi Series: What is Yield Farming and Liquidity Mining?
In the current case, one of its investments was in a DeFi token called staked ether (stETH) which is supposed to be pegged to the No. 2 cryptocurrency. It’s distributed by a firm called Lido, which takes investors’ ether and stakes it in the staking pools being created to secure Ethereum when it becomes a proof-of-stake blockchain in the next year or so.
Learn more: DeFi Series: What is Staking?
The problem is those stake ether tokens started trading for a larger and larger discount — not too dissimilar for a stablecoin “breaking the buck” — causing other stETH investors to run and making it harder to redeem, CoinDesk reported.
It added that Celsius had about $470 million in staked ether on its books, and had to start selling as its own investors started withdrawing funds in growing numbers — as did other big buyers in trouble, notable Three Arrows Capital, which is rumored to be insolvent.
Read also: Crypto Crisis Evokes 1998 Hedge Fund Crash that Crippled Market
Thus, the problems of staked ether became connected to Celsius.
That’s a problem that requires stronger regulation of crypto lending platforms in general former Commodity Futures Trading Commission (CFTC) Chairman Timothy Massad told CoinDesk on June 15.
“A lot of people have losses who didn’t understand the risks they were taking,” said Massad said. Pointing to the interconnections, he said there is a risk of contagion when “people just start getting worried.”
Such as when the crypto market starts collapsing.
Trouble With Regulators
In March, after the Securities and Exchange Commission (SEC) warned exchanges to account for customers funds as liabilities, Celsius restricted itself to accredited — rich or institutional — investors.
And it has called this type of lending unregistered securities — much as it did to BlockFi which paid a $100 million fine to the SEC and a number of state regulators over its interest-bearing accounts.
Also see: BlockFi’s $100 Million Settlement With SEC Raises Internal Discussion
And, Celsius has had troubles with a number of state securities regulators, including New Jersey, where it was ordered to stop doing business.
The Texas State Securities Board’s director of enforcement told Reuters it had begun an investigation after the withdrawal freeze.
“I am very concerned that clients – including many retail investors – may need to immediately access their assets yet are unable to withdraw from their accounts,” Rotunda said. “The inability to access their investment may result in significant financial consequences.”
The agency started looking into Celsius back in September, saying at the time it wanted to “get Celsius in compliance with the law so it can continue to operate legally and legitimately while protecting its clients and their assets.”
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