Celsius ($CEL) is one of the biggest centralized crypto lenders, offering 5 –18% APY on deposited crypto, while also allowing crypto-backed loans at 0.1-1.95% interest rate. The majority of its profits however come from operations on the crypto market, making Celsius somewhat akin to an asset manager, and a rather important one: the company is managing over $11 billion in customer assets.
The operations that Celsius undertook on the market included staking over two-thirds of its 1 million ETH holdings at ETH 2.0, a blockchain that is set to merge with Ethereum Mainnet this year, effectively switching it to the Proof-of-Stake consensus. Staking crypto on PoS blockchains secures their functioning and is rewarded with coin issuance and transaction fees; in case of ETH 2.0, the maximum APR of staking ethers is of 5%.
There’s an inconvenience to Ethereum staking, though, as it locks the coins for a long period of time, naturally creating liquidity problems both for Celsius and its clients. To avert this problem, Celsius uses a DeFi protocol called Lido, which is offering a liquid staking service: for every staked ETH it gives an stETH token, which acts like an IOU and allows its holders to trade and otherwise use their staked ethers without actually removing them from ETH 2.0.
Liquidity crunch
1 stETH should normally be worth 1 ETH at all times… except if there were an imbalance on the market, e.g. due to a massive sell-out of stETH. And this is exactly what happened.
The bear market has pushed many Celsius clients to withdraw their ethers, and as the rumors of its imprudent over-exposure to stETH started to spread, the withdrawals increased too, forcing the company to sell more and more stETH. At the same time, Three Arrows Capital, a hedge fund manager suffering from the market sell-off, started to dump its own stETH, flooding the not-so-liquid market. Unsurprisingly, it ended up in stETH losing its parity with ether and dropping to 0.94ETH.
This drop is not without dangers of its own: Celsius is known to have taken stablecoin loans at DeFi lenders Aave and Compound, depositing its stETH as collateral. If stETH price keeps dropping, these deposits are at risk of being partially (or totally) sold out, making the situation even worse. So, at that point Celsius decided to halt all withdrawals.
What’s next?
Celsius is used by 1.7 million people all over the world, and those people are angry. Crypto Twitter is now full of desperate traders who are facing their own margin calls, but cannot add any more collateral, because their crypto is stuck at the company that used to advertise a “free and unlimited access to your own funds.”
Being a CeFi (as opposed to DeFi) means that Celsius is de facto in possession of its client’s crypto and can unilaterally decide what to do with it. However, as abhorrent as it may sound to decentralization advocates, this can also allow the firm to try and save their holdings, by taking a loan or in some other less obvious way.
One of such ways could be selling itself to its competitor Nexo, which has recently announced its intention to buy from Celsius the “remaining qualifying assets”, providing immediate liquidity for its clients. Taking into account that halting withdrawals has dealt a severe blow to Celsius image, maybe this could be not such a bad idea?
As of now it is still unclear which next step Celsius is going to take, but we can see it topping up its $500 million Bitcoin position at MakerDAO, a DeFi (hence publicly visible) lending protocol. Will it be enough to avoid liquidation, and how many of similar positions the company also holds, is not quite certain.
Crypto finance, be it centralized, decentralized, or a mix of both, is a recent phenomenon, and this bear market is its first real challenge. It will test the resistance of current methods, separating the wheat from the chaff and defining the practices and the regulations of tomorrow. We only hope that the consequences on retail investors could be minimized.
Written by D.Center
