Celsius update (based on info from Chapter 11 filing and lawsuit by KeyFi)

In March of 2022, Celsius had over $22 Bn in assets. On Jul 14th, 2022, Celsius declared Chapter 11 Bankruptcy Protection claiming that it had $4.3 Bn of assets and $5.5Bn in liabilities.

Section B: Events leading to the Chapter 11 filing:

a.????Platform grew faster than expected and the company made poor deployment decisions, leaving the company with disproportional liabilities when measured against unprecedented market declines.

Analysis: People and companies make operational mistakes. Sometimes these mistakes are not immediately obvious. Rising markets can be very forgiving while declining markets can be equally punitive. It’s a good sign that the company is acknowledging this.

b.????Market factors: The company talks about high inflation, the war between Russia and Ukraine, the well-publicized fall of Terra and overall crypto winter as reasons for massive sell offs (flight to quality) by their customers. They talk about this sell-off leading to losses.

Analysis: On Celsius’s website they make it sound like deposits on their platform are a high-yield alternative to traditional banking – “Our goal is to allow anyone and everyone to unbank themselves and enjoy financial freedom. We provide access to fair, rewarding, and transparent financial services”. Yes, banks are engaged in taking deposits and deploying it in loans. Yes, these loans can be secured (mortgages, HELOC, auto loans) or unsecured (credit card, student loans etc). Yes they have credit risk risk (e.g., defaults on credit card balances) and duration risk (5 year Auto loans to 30 year mortgages). Three important distinctions are:

i.??????????????Banks do not have to seek out highly speculative investments (they offer very low interest rates and for the most part,

ii.?????????????For the most part, banks do not have asset-liability mismatches – meaning they are accepting deposits and making loans in fiat

iii.????????????Banks have access to interbank loans and the Fed Funds window for short-term borrowing to meet any obligations

Celsius was engaged in highly speculative investments. As they were offering 18% on deposits, they needed to seek investments where they could make returns more than what was owed on deposits. They likely had asset-liability mismatches.

For example, if they accepted deposits in stable coins and lent out or staked in ETH, this strategy would have worked wonders in a growth market. E.g., let’s assume the price of 1ETH was $2,000. A $2,000 deposit would have allowed Celsius to lend or stake 1 ETH in a longer-term investment. In a growing market (say the price of 1 ETH went to $3,000), Celsius could have redeemed the $2,000 deposit (plus say $360, or 18% interest) and still be left with profits from the unrealized gain of $640.

The converse is true in a bear market. If the price of 1 ETH fell to $1,000, Celsius would have had to pay $2,360 against an asset with market value of $1,000. Knowing that these are highly volatile assets, a smart company would have employed hedging strategies to compensate for these types of risks. Also, if your business model needs to take on some duration risk, it should be modeled such that a higher percentage of loans are shorter-term in nature, so that investors can be paid off in some reasonable time, even if there was a run on the company’s assets.

Celsius basically had a poor risk management strategy and has instead chosen to blame the economy, Russian war on Ukraine, overall crypto winter and sell-offs as the reason for their downfall.

c.????Let us start with a look at the (very summarized) financials provided by the company.

Here’s Celsius’s explanation on the asset position since March 2022:

1.????User withdrawals: $1.9Bn

2.????Decline in market value of holdings: $12.3 Bn

3.????Crypto liquidation by third parties (Tether): $0.98Bn

4.????Crypto lost from investments: $0.18Bn

5.????Loans: $1.9Bn due to loan redemption and liquidation

Celsius has indicated that these numbers are measured on a non-GAAP basis. This is a bit concerning because they may not be applying conservatism principles. This means it is unclear if the financials are reflecting changes in the value of assets, allowances for bad debt based on GAAP or not (i.e., the impairment could potentially be bigger than what they are posting). If assets and liabilities were matched, any decline in market value of an asset would be immaterial – i.e., if you took 1 ETH in deposit and lend out 1 ETH, the price of ETH in USD would be immaterial on the company’s balance sheet. However, if the company took stablecoin deposits and lent out in ETH, you might have significant impairment in your assets.

Celsius’s main defense has been that all digital assets transferred to Celsius as part of the services are owned and held by Celsius for its own account.” Further, the Celsius Terms of Service state that “Celsius does not hold any Digital Assets on your behalf” but instead are “owned, held and/or controlled by Celsius.” In other words, Celsius not only acknowledges that it treated customer funds like their own money, but it in fact makes the legal claim that these funds were their own.

Case in point – Celsius decided to become a large crypto miner and decided to use customer deposits to make an inter-company loan to its mining subsidiary to the tune of $700M.

To try and generate extremely high yields, the company also entered into a handshake agreement (for mutual benefit based on mutual respect and trust) to transfer hundreds of millions of customer deposits to a wallet managed by KeyFi, which invested these funds in speculative hedge-fund like strategies.

In a lawsuit by KeyFi against Celsius, KeyFi claims that Celsius was using customer funds to manipulate crypto-asset markets (e.g., using Bitcoin deposits to inflate its native CEL token). If these allegations prove to be true, Celsius and its leadership will have a lot more to worry about than civil proceedings or investigations by state regulators.

Links:

1. https://pacer-documents.s3.amazonaws.com/115/312902/126122257414.pdf
2. https://iapps.courts.state.ny.us/nyscef/ViewDocument?docIndex=RvF30Mz2IZW63s1mjjau2Q==