Celsius - What can we learn?
Celsius was established in 2017 and formed part of the decentralized finance movement intending to operate like a traditional bank for crypto. It offered customers the opportunity to deposit their crypto and earn up to 17% interest whilst other customers could apply for loans collateralized by their crypto deposits.
In June 22 it came crashing down when Celsius informed its customers it had frozen their assets which, in turn, sent ripples through the broader crypto market. The following month the company filed for Chapter 11 protection with the assurance it intends to maximize returns to creditors and set its affairs in order.
What happened?
In short, no one knows for certain but it seems that Celsius’ business model involved staking its customers’ ETH through Lido Finance in order to boost Celsius’ profits. Celsius would trade its customers’ ETH for a stETH token on a one to one basis so it could participate in Lido Finance’s ETH Staking pool. Problems arose when the stETH token de-pegged from ETH. This meant that Celcius owed its customers , (i) the original value of their ETH, plus (ii) a 6.5% return (interest on ETH deposit accounts), all whilst holding a stETH coin which was worth significantly less than the original ETH the customer deposited.
Not only could Celsius not pay its customers the interest they had promised, they couldn’t give them their ETH.
So, what can we learn…
If it sounds too good to be true it probably is - promising returns of up to 17% for depositing crypto should set alarm bells ringing (just think of what your traditional bank is paying on your deposits). Celsius had a noble goal of offering an alternative banking system but exposed itself, behind the scenes, to a type of crypto engineering that mirrors the approach of traditional banks and the financial engineering they engage in (without the regulation, oversight and experience). If the returns don’t match the risk proceed with caution.
Networks, crypto and tokens are sometimes dangerously interlinked - Celsius’ business model was working well as long as stETH kept its peg to ETH and what could possibly go wrong with stETH? Well, there was a sudden rush to trade stETH for ETH as a result of Terra’s implosion which caused huge downward pressure on stETH. In short, too many people were trying to get out of their stETH and exchange for ETH so it lost its peg and 1 stETH was no longer worth 1 ETH. Celcius’ failing was to be too myopic in only trusting the Lido network and failing to appreciate how a shock to stETH, i.e. a risk outside Lido’s network, could decimate its own business model.
Risk management is essential - the ambition of Celsius and Lido is admirable and the principles on which they are built will, when things have calmed down in the future, undoubtedly challenge the established financial order. However, offering a new medium of exchange and forum on which to do it must be treated with immense caution. For all its faults, the financial system bemoaned by proponents of de-fi has weathered some truly stupid and fraudulent events. But this means the risks are well documented. We are only just beginning to see the first rumblings of how de-fi can mess things up which means we must look to the past when assessing the present.
The Celcius Chapter 11 proceedings are already throwing up a number of thorny issues that are being watched with interest. What legal principles will be derived historic finance laws and precedent remains to be seen.