Understanding what happened to Celsius and other crypto lending firms

A group of dogs in an oil painting style sitting around a table playing poker.

If you don't know who the bad poker player is around the table it might be you

You've probably all heard about a company called Celsius by now. They are one of many crypto lending/borrowing platforms who are severely struggling this crypto winter. Recently they filed for bankruptcy (Chapter 11) and revealed a $1.2 Billion hole in its balance sheet.

Investors that had deposits with Celsius may one day get a portion back but they are also currently facing the possibility of total loss.

Let's run a deep dive on what happened and the economics behind why this has happened.

If you don't know where the yield is coming from, you are the yield.

In late 2021 and early 2022, Celsius was flying as their CEO Alex Mashinsky hit the circuit spruiking Celsius' yield offering. While he was called out by multiple people including Tone Vays, Saifedean Ammous and even Peter Schiff, Celsius seemed to grow. We saw Celsius selling their yield product first hand at Bitcoin Miami 2022.

The offering was significantly higher interest on deposits than you could get in your bank. While it seemed great and lured a huge volume of investors it turned out that funds deposited were used for various other purposes not revealed to depositors which opened up Celsius to significant risk.

When the market price of cryptocurrency tanked in 2022 the risk management practices caused an unavoidable issue that Celsius didn't have enough cash on hand to meet client withdrawals and Celsius stopped all withdrawals. This was the beginning of the end and finished with bankruptcy.

Celsius CEO, Alex Mashinsky wearing a shirt that says banks are not your friends

Risk vs Reward

All investing regardless of asset type comes back to the age old principle of risk vs reward. The general consensus is as follows:

Higher risk = higher returns
Lower risk = lower returns

In the Celsius case investors piled in thinking that the yield on offer was some sort of unique blend of higher returns with a lower risk profile, partly due to grandiose promises purported by Celsius themselves but also due to a lack of education, thinking that Bitcoin and other crypto assets when deposited with these "crypto banks" was as safe as a bank term deposit.

This ended in disaster as the outcome was that they lost their deposit altogether through not realising where the yield was coming from. You see Bitcoin in and of itself stored properly does not have a yield.

If you don't know where the yield comes from you are the yield.

a picture of a mousetrap where the United States 100 dollar bill is used as bait

Whenever someone is willing to pay you interest/yield you must (as a sensible investor) find out how that yield is generated. If you don't understand where it comes from and you invest you are opening yourself up to unacceptable risk. Moreover, you ARE the yield if the money you deposit is actually going to someone else.

Bernie (The Ponzi King) Madoff

Bernie Madhoff in his office where he run a fund which was embezzling money and ended up stealing billions of dollars

You may have heard of Bernie Madoff who orchestrated the worlds biggest Ponzi scheme worth $64.8Billion USD. A Ponzi scheme works by paying investors withdrawing their funds from the deposits of new investors.

Bernie for example promised incredible outsized yield (returns), took client funds and stored them in an account. As his fame grew more and more money flowed in from people seeking yield but not understanding where it came from.

The financial crisis finally brought Madoff undone. The crisis caused investors to withdraw funds for their own needs all at the same time and Bernie couldn't pay as there was no new deposits coming in to honour all of the redemptions. He destroyed the investments of Universities, Family, and long time clients.

Lehman Brothers, Banking and Hypothecation

Unsurprisingly yield games and ponzis predate cryptocurrency. It was Banks that essentially invented hypothecation which is the practice of using mortgaged assets as collateral for their own borrowings.
So essentially using borrowers' houses as their own collateral for further loans.

Lehman Brothers, the failed Investment Bank that was the famous first domino of the 2008 GFC had collateralised so much debt that over 90% of their assets were collateralised. Their added risk sent them all the way to Bankruptcy when market prices exposed their significant risk. Institutions that chased the yield and lent to Lehman Brothers faced bankruptcy themselves but were in large part bailed out by the taxpayers.

In the crypto space bail outs are unlikely so know what you are getting into or be safe and keep your assets protected.

Stormrake Custody

Stormrake custody is the low risk setting where you are not chasing yield but you are rewarded with protection of your capital. There are multiple reasons for why we offer our service this way:

The priority is security of funds and preserving capital
Wherever possible, client funds are held off exchange, in cold storage multi-sig wallets
3) We do not offer yield and therefore our clients do not face rehypothecation risk
To allow us the ability to honour redemptions and withdrawals regardless of market cycles

On a final note, we also provide education to our clients on how to safely custody their own digital assets, bearing in mind they also have to take 100% of the risk for managing the ongoing safe keeping of their investments.

As a result no client funds have ever been lost due to stringent risk management and responsible service offerings.

General Advice Warning

The information provided in this newsletter is general in nature only and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information contained here you should consider the appropriateness of the information having regard to your objectives, financial situation and needs. Therefore, before you decide to buy any product or keep or cancel a similar product that you already hold, it is important that you read and consider the relevant Product Disclosure Statement (PDS) of the product provider to make sure that the product is appropriate for you. Before making any decision, it is important for you to consider these matters and to seek appropriate legal, tax, and other professional advice. You can get a copy of relevant PDSs from Stormrake by email custody@stormrake.com.

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