Celsius’ crisis exposes problems of low liquidity in bear markets

Third-party custodians like Celsius failing is a reminder of one of the most basic principles of crypto; not your keys, not your coins.

After one week of pausing user withdrawals, swaps and transfers, the firm said it was maintaining an open dialogue with regulators and officials and plans to continue working with them regarding this pause. Celsius has yet to comment on when the company is going to stabilize its operations. Celsius has also paused communications on Twitter Spaces and ask-me-anything (AMA) sessions “to focus on navigating these unprecedented challenges.”

Although Celsius has refrained from communication, media and social media have been buzzing with news and speculation going on around the past, present and future of the company. One of the most interesting developments is a community-led Gamestop-style short squeeze.

The dust from the Terra debacle hasn’t yet settled and but another crisis is shaking up crypto markets. The multi-billion-dollar crypto lending and staking platform Celsius is the latest crypto company to be beset by controversy. 

Earlier anomalies 

Celsius’ tagline is, “An economy where financial freedom doesn’t come with a price tag.” This marketing tagline, although unbelievable for some, was truly effective for some time. Since opening its doors in 2017, the company had roped in over $25 billion in crypto over five years until things came to a head on June 12, 2022, when the company paused user withdrawals.

However, signs of Celsius’ mismanagement of funds were visible prior to this instance. In December 2020, during the $120 million BadgerDAO hack, Celsius reportedly lost over $50 million worth of crypto, making them the largest single victim of the act. To recompense victims for their losses, BadgerDAO enforced a restitution plan by creating the remBADGER token.

Token holders were assured a payout in remBADGER over the next two years that would cover the remainder of the loss. This assurance came with only one requirement: The remBADGER must remain within the Badger vault. If the token were to be withdrawn, all future repayments would be forfeit. However, on March 18, 2022, Celsius withdrew all of its allotted remBADGER, worth roughly $2.1 million at the time of the transaction.

When Celsius Network realized its mistake, it tried to convince the Badger team to allow it to re-deposit in violation of the rules set forward by the BIP-80 resolution. Unfortunately, for Celsius, the BadgerDAO took the code is law ethos earnestly, and the proposition was voted down.

Many users have also been concerned about the firm’s leadership. Celsius chief financial officer Yaron Shalem and chief revenue officer Roni Cohen-Pavon were both arrested for money laundering in November 2021

On May 11, 2022, when the Terra debacle was just starting to unfold, some began to look at Celsius. Cointelegraph then reported that the Celsius Network had started to deny rumors of significant losses to the company. Celsius chief financial officer Rod Bolger had said, “Our front office teams [...] think and act as risk managers to ensure that we are not exposed in any significant way to market swings.”

All funds are safe. We continue to be open for business as usual

As part of our responsibility to serve our community, @CelsiusNetwork implemented and abides by robust risk management frameworks to ensure the safety and security of assets on our platform.

— Alex Mashinsky (@Mashinsky) May 11, 2022

Investors had accused the Celsius team of sitting on its hands while token price tumbled as a result of the Terra fiasco. On May 20, 2022, Celsius (CEL) had fallen from its all-time high of $8.05 to $0.82, which is a 90% drop. Some Celsius users claimed that the platform liquidated their holdings as CEL dropped. They suggested that trading was illiquid as the price fell, worsening their losses. When Cointelegraph contacted the CEO of Celsius, Mashinsky attributed this to the “Shark of Wall Street,” stating:

“They took down LUNA. They tried Tether, Maker and many other companies. It’s not just us. I don’t think they have specific hate or focus on Celsius. They are all looking for any weakness to short and destroy. The point is that the Sharks of Wall Street are now swimming in crypto waters.”

The problem with high-yield APY projects

Celsius was one of the fastest-growing institutions in the crypto market. Up until the collapse, Celsius had 800 people working for them, with the employee count increased by over 200% in just the last year. The problem is that crypto is in a bear market now and to keep on functioning normally, companies need to continue having liquidity. Now, when most retail investors and institutions are pulling their crypto out, liquidity becomes a major concern for them.

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One of the biggest reasons for the collapse of Terra was also illiquid assets. However, most projects, when asked about how their individual projects, claim to be on a different business model than the project that is in trouble at that instance. Cointelegraph had reached out to Synthetix to clarify why their lucrative business model of high yield annual percentage yield (APY) was more well-founded than the ones that went down like Terra and Celsius. Their representative replied:

“Several accounts have attempted to draw parallels between Synthetix and LUNA. And, while there might be a surface-level similarity, ultimately the tokenomics and collateralization mechanics of Synthetix are much more robust and battle tested than LUNA. Further, while the top line APY appears high, that number is derived from two distinct sources.”

“Trading fees in sUSD, which is revenue from transactions generated by our ecosystem partners like Kwenta, Lyra, 1Inch, Popcorn Finance and others make up a portion and depending on the previous week’s volume have contributed between 5%–25% of the weekly staking rewards. Inflationary supply, is the second source of weekly APY, and contributes the remaining APY amount, and is currently at a roughly 50% annual growth rate. That inflation amount is minted weekly and is currently distributed between stakers on ETH mainnet and Optimism,” they added.

Liquidity crunch in crypto mirrors traditional markets 

What we are seeing now in the crypto ecosystem is all the lessons learned over the past 100 years in the traditional finance system playing out. As the ecosystem matures, crypto markets will inevitably become cyclical, just like traditional markets. To weather the downturn, projects must learn from the past. This doesn’t mean crypto loses its edge, just that there are smart principles of sustainability that are applicable to any emerging market. Loren Mahler, CEO of Jupiter Exchange, stressed that most financial markets are fundamentally similar and prone to become illiquid during the inevitable bear run. She told Cointelegraph:

“One of the most important is the issue of liquidity. An emphasis on rapid user growth at all costs is not a sustainable philosophy. Offering outrageous staking rewards on the most mundane activities is naturally going to create a run on the system, whether in crypto or traditional banking. The projects that innovatively apply these traditional finance lessons are going to be best positioned to capture new growth opportunities when the cycle turns again.”

Giant projects like Terra and Celsius going under tend to have a cascading effect on the broader market which is well evident from the plummeting prices of most cryptocurrencies. The sentiments of retail and institutional investors are bound to become overwhelmingly negative. Although, Lilly Zhang, chief financial officer of Huobi Global, saw a way out of the domino effect of liquidation. She told Cointelegraph:

“The market could see further declines as more liquidations occur and players are forced to sell, and companies and investors who have made poor decisions will be hardest hit. Trouble at Celsius, in turn, also made traders worried about Staked Ether. Fortunately, as the selling pressure on stETH continues to increase, more demand will seep into the second-hand markets and create cheaper stETH prices that may be attractive to new investors, which will in-turn increase demand and drive prices back up to normal.”

Not your keys, not your coins

“Not your keys, not your coins” is a popular expression in the world of cryptocurrencies which refers to needing to own the private keys associated with your funds. The person owning private keys is the one deciding how the crypto assets associated are spent. Failing to do so means that we entrust a third party to hold our coins safely for us. Stories like the Celsius one are an eerie reminder that these third parties often do not act in the self-interest of their clients. 

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Although the popular takeaway from this story has been that people should hold the keys to their crypto, there have been people like Sung Hun Kim, CEO of Metaverse World, who pointed out that the problem lies in centralized projects like Celsius. In an interview with Cointelegraph, Sung said:

“When discussing security issues, it is less about how and more about why. Both centralized and decentralized structures are not impregnable, however, Celsius being inherently closed-circuit affects the right of the customer to assess the growing risk. It is not about who stores the keys, but the level of transparency a project is willing to provide.”