I feel fooled by crypto but still remain optimistic. Here is what I have learned in the last two weeks.

Understanding ‘Yielding’: The Controversial Money-Making Strategy That Brought Celsius to Its Knees

On Monday June 13, Celsius customers awoke to find an email awaiting them. “Due to extreme market conditions,” it began. “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 honour, over time, its withdrawal obligations.”

Rumours around Celsius ’ solvency had been swirling for months. Nevertheless, the news that it had effectively locked all customer deposits until further notice came as a shock. Like myself, many of the platform’s 1.7 million customers are relative novices to the world of cryptocurrency. Naturally, they trusted the US company, which was founded in 2017, with their money.

As the news reverberated across the cryptosphere, shared through Telegram groups, Discord channels, and Twitter, attention turned to the controversial way in which Celsius had been making – and occasionally losing – money. Concerningly, it was through a practice known as yield farming or simply ‘yielding.’

Some definition before you go on and read.

“Staking” offers crypto holders a way of putting their digital assets to work and earning passive income without needing to sell them.

"Yield" refers to the income earned on an investment over a particular period of time.

“Yielding (or Yield farming)” - is the process of using decentralised finance to maximise return. Yielding is when crypto owners and companies lend or borrow crypto using a platform and earn crypto in return for their services.?

People and companies using yield farming can increase their gain by employing complex tactics and shift from one platform to another who promise higher returns. It is a risky practice.?

Yield Chasing on an Industrial Scale

Celsius is a web and mobile application that enables customers to store, send, and swap cryptocurrency, effectively acting as a blockchain bank. It promises its customers that they can “earn up to 17% APY,” but is opaque about the processes used to generate that yield.

Bitcoin (BTC) is not a yield-generating asset. Owning BTC does not entitle you to earn additional BTC in the form of yield. Other cryptocurrencies do, often in the form of staking rewards. Staking describes the process by which a person locks up their crypto tokens for a fixed period of time in return for additional tokens by way of reward. Celsius, for example, offers 7% APR for holders of its CEL token who stake it within the app.

It’s easy for Celsius to honour that reward since it controls the emissions of its native token. Giving away your own token to customers can only go so far. To reap greater revenues, and share the bulk of these with its expectant customer base, Celsius was compelled to take customer deposits and transfer them to numerous crypto networks and protocols in the pursuit of pecuniary gains.

To those willing to dive beneath the surface to understand where Celsius’ generous yields were coming from, it was evident they were investing customer deposits in third-party protocols. But the extent to which it was playing fast and loose with others’ money has only become apparent in recent days.

How Yield Farming Works

For an entity such as Celsius, yield farming on an industrial scale, there are two steps to the process. The first is to aggregate customer deposits such as ETH or WBTC (tokenized BTC on Ethereum) and deposit it into a lending platform such as Aave or Compound.?

These platforms provide stablecoin loans in return for crypto collateral. An entity can obtain a loan of around 50% of the value of the collateral they have deposited. Should the price of the collateral (e.g. ETH, BTC) drop in value significantly, the entity must post more collateral to avoid being liquidated.

After being loaned USDC, Celsius converted a portion of the stablecoin into other assets such as CRV (the governance token of Curve Protocol), using it to provide liquidity on decentralised exchanges in return for a share of the trading fees. The profits were then indirectly returned to Celsius customers. Essentially, they were taking money from Peter to pay Paul.?

Yield farming with hundreds of millions of dollars is a risky business, not only on account of the volatility of crypto assets, but due to the danger of a protocol bug leading to loss of funds. Celsius is known to have lost funds three times in this manner up until this week’s events, including in the hack of Badger Finance in 2021.

To compound its problems, Celsius converted a significant portion of its clients’ ETH to staked ETH (STETH ), an illiquid derivative that cannot be accessed until late 2022. When the crypto market started to crash, Celsius customers demanded their ETH back so they could cash out. But there was a problem: much of their funds were tied up in STETH or deposited into lending platforms that Celsius was frantically having to top-up with other customer funds to avoid liquidation.

And so it was that one of the largest crypto saving apps in the world was forced to dispatch that infamous email on June 13, begging for time to set its affairs in order.

Denial Gives Way to Anger

Celsius customers, some of whom were already out of pocket due to the collapse of Terra and its UST stablecoin in May, have been left seething over the opacity of Celsius’ fiscal policy that caused the current imbroglio.

To yield is to cede control or give way to another. And for the customers of Celsius like myself, that is to all intents and purposes what they did with their funds: ceded them to the crypto custodian to control and invest as the company saw fit. Celsius appears to have acted with the interests of its customers at heart – but that’s not to say that its actions were beyond reproach.

If Celsius was playing fast and loose with customer deposits in the name of squeezing a little more profit, that would be reckless behaviour. It might be expected of a single-man pseudonymous team operating on Telegram, but it is not the behaviour of regulated companies with billions of dollars of assets under management.

Celsius is now reported to have hired restructuring lawyers as it deals with a deluge of customer claims and complaints. As for its 1.7 million customers, they face an anxious wait to discover when – or if – they receive their money. At the height of the crypto bull market, yielding seemed a smart strategy to make everyone richer. In the depths of a bear, it feels like peak insanity.

Like many people who got into crypto, I had – and still have – high hopes that the movement could provide greater financial inclusion and financial wellbeing. Crypto’s transparency and egalitarian design (all transactions are viewable on-chain and all customers are treated as equal) was meant to be its selling point. And yet, through subterfuge and sleight-of-hand, some of the industry’s largest players have created their own shadow banking system.

If the industry cannot learn from these mistakes and ensure they are never repeated, it is no better than the traditional institutions it set out to replace.?

I am glad to be working for a crypto company that from the outset has taken a compliance first approach, because our founders although it wasn't an easy path, believe in the future of crypto and recognised that for this future to be true it needs to work in the highest standards.

If anything, I hope that the Celsius scandal will serve as a wake up call for all crypto companies to work with regulator, reappraise their policies and values they espouse.?

Crypto deserves better.