Crypto Platform Celsius Pauses All Withdrawals. What Are Crypto Yield Platforms? How Do They Work? And How Did This Happen? (#107 - 14 June 2022)

This week popular crypto lending platform Celsius announced an immediate pause of all withdrawals, swaps, and transactions off of the platform. Coinciding with a broader market decline, the Celsius news has obviously had a huge impact on the ecosystem.?

In the latest issue of the newsletter, I explain what these crypto lending platforms are, analyse what may have triggered this development, and share my key takeaways on what to watch in the coming months.?

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Here we go!

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Crypto markets have had a brutal couple of days. Bitcoin fell below $22,000, Ethereum fell under $1,200, and crypto’s total market cap plunged beneath the $1 trillion mark.

But the major news this week has been crypto lending platform Celsius announcing an immediate pause of all withdrawals, swaps, and transactions off of the platform.?

Coinciding with a broader market decline, the Celsius news has obviously had a huge impact on the ecosystem.?

(For full disclosure, Celsius has been a sponsor of my educational content in the past and I have had their CEO, Alex Mashinsky, on my podcast as well).

But before we talk about Celsius, it's important to explain how yield platforms work (for the crypto aficionados, you can simply scroll down).?

What Are Crypto Yield Platforms??

There are essentially two types of yield products: those offered by centralised entities (e.g. BlockFi, Ledn, Celsius, Nexo, and Yield App) and those offered by decentralised platforms (e.g. Aave, Compound).

The mechanism is quite simple.

A user that has crypto (e.g. Bitcoin, ETH, USDC) can lend that crypto to the platform and in exchange will receive some interest.?

The platform will then go and lend that crypto to either institutional investors or retail traders for a higher rate and pocket the difference.?

Source: Kraken Intelligence

Whilst the same offering exists on DeFi platforms, the average retail crypto trader is likely to use a centralised platform as they tend to be more user-friendly, offer customer support, and do not require technical skills.

Source: Kraken Intelligence

However, trading using such centralised exchanges contains certain risks.?

The most obvious risk is counterparty risk. For example, whilst these platforms will always over-collateralise their loans (e.g a client can only borrow $5,000 for $10,000 worth of crypto), the risk always remains that crypto markets will rapidly fall and clients will not be able to meet margin calls or the exchange will not be able to liquidate the collateral in time due to adverse market conditions or simply bad risk management.

Also, unlike leaving your money in a bank, for instance, there is no FDIC-like insurance for such products in the event the platform goes bust.

The second risk to be aware of is hacking or cyber risk.

In a DeFi platform, you as the user hold the private keys and, thus, custody of your assets. Whereas in a centralised lending platform, you transfer your crypto to the platform.

This leaves open the inherent risk of a hack, as a bad actor can swoop in and succeed in hacking that platform or the custodian that holds the funds for that platform.

The third consideration comes down to traditional fraud risk.

For example, a platform may not be able to give back your funds due to fraudulent activity or negligent risk management. The bankruptcy of lending platform Cred in 2020 was a good example.?

However, the reality is that people are generally happy to lend out their crypto, as they are able to earn a yield on it.

And although yields for crypto lending have come down in recent months, they remain quite appealing, especially when compared to traditional financial instruments.?

Source: Kraken Intelligence?

As many crypto investors are holding Bitcoin and other crypto-assets for the long term, such yield enhancement products allow them to generate some returns on their assets whilst they “hodl” them.?

Whilst the above relates to centralised lending platforms, it's important to understand that the same offerings exist in the DeFi space as well, with platforms from Aave to Compound offering similar products but in a decentralised fashion.

Although DeFi has many benefits, from being permissionless to eliminating counterparty risk, some inherent risks remain, like smart contract risk.

And despite the fact that there are lots of people reviewing such smart contracts, the risk always remains.?

But whilst DeFi platforms are used actively by crypto aficionados, they are more difficult to use by the regular retail public, at least for the moment.

This is why many crypto users prefer to use such centralised lending platforms.

Which brings us to Celsius.

What Is Celsius and What Happened?

Valued at $3.25 billion as recently as last November, Celsius was one of the biggest lending platforms in the ecosystem, allegedly holding over $24 billion of assets at one point.

The platform allowed users to earn extremely attractive yield rates on their deposited assets.

Celsius would then lend those assets out to other market participants, from crypto funds to exchanges, who would use those assets for a broad range of trading activities.?

However, on Sunday evening, Celsius announced an immediate pause of all withdrawals, swaps, and transactions off of the platform.?

"Due to extreme market conditions, today we are announcing that Celsius is pausing all withdrawals, Swap, and transfers between accounts.?We are taking this action today to put Celsius in a better position to honor, over time, its withdrawal obligations.

Acting in the interest of our community is our top priority. In service of that commitment and to adhere to our risk management framework, we have activated a clause in our Terms of Use that will allow for this process to take place. Celsius has valuable assets and we are working diligently to meet our obligations.

We are taking this necessary action for the benefit of our entire community in order to stabilize liquidity and operations while we take steps to preserve and protect assets."

Source: Celcius

Potential signs of trouble had been brewing around Celsius for some weeks.?

Many believed that the platform was active on the Anchor protocol with UST, one of the catalysts behind last month’s collapse of Terra’s stablecoin and sister cryptocurrency, LUNA.

Others feel that the de-pegging of staked ETH on the Lido platform dealt another blow as well, with the company holding at least $450 million worth of stETH in a public wallet.

And the overall market crash coalesced into a perfect storm, with Celsius’s native token - CEL - dropping 70% in a single hour.??

Regardless of how the Celcius sag unfolds, it will have a major impact on the broader crypto ecosystem.

What Are the Developments to Watch?

First, this should be a wake-up call for the industry to have such platforms make public their proof of reserves.?

But the reality is that if the platforms don't do this, the regulators will.?

Some platforms had taken positive steps in this direction in recent months.

Nexo for example publishes a real-time attestation of its accounts.

Such disclosures or attestations have now become common with stablecoins (a topic that we have covered in this newsletter before) and it is perhaps time to see the same level of transparency with crypto lending platforms.?

These disclosures are not perfect but, at least, a step in the right direction.

For example, stablecoin issuer USDC publishes a monthly reserve account.

Tether also publishes a quarterly independent accountant’s report, which includes a consolidated reserves report.?

Source: Tether

The second thing to watch is what will happen to some of Celsius’s peers.

There are numerous lending platforms (a topic we have covered in this newsletter in the past). Firms like Nexo, BlockFi, Ledn, Hodlnaut, Yield App, and the list goes on. (For full disclosure, some of these firms like Yield App have been sponsors of my educational content in the past). It will be interesting to see if there is contagion to some of these platforms by users withdrawing funds.?

Some used Celsius’s troubles as a marketing opportunity.

For example, Nexo took advantage of this situation by issuing a letter of intent on buying some of Celsius’s assets.?

For now, it seems that the broader lending ecosystem, as well as crypto exchanges, are not hurt in the same way as Celsius, but it is difficult to determine the level of damage at this stage when the level of leverage in the system is not clear and when there is no clarity as to whom holds what type of assets. Whilst few would consider Celcius to be systemically important, it remained regardless an important and very large player in the crypto ecosystem.

And the final thing to watch will be what takes place with regulators and policymakers.

Regulators and policymakers have no shortage of ammunition now, from the collapse of Terra to the pausing of Celsius’s redemptions.?

In the same way that the collapse of Luna catalysed a wave of policy-making on stablecoins, we should expect the same to happen here, especially since the number of retail users hurt is large (e.g. Celsius had allegedly over 1.7 million customers).

Firms like Celsius were involved in numerous enforcement actions from regulators in recent months, from New Jersey and Texas to Alabama and Washington, and this week’s events will give even more ammunition to such regulators.

This is definitely a development worth following over the coming days.?

Regardless of how this week's events unfold, they will have a long lasting impact on the global crypto ecosystem.

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Henri Arslanian

*Please note that this newsletter reflects Henri’s personal views and not those of any organisation he is involved with. This newsletter is for educational purposes only and none of its content should be construed as investment or financial advice of any kind.?