The background of Celsius' insolvency filing
Putting Celsius' insolvency into context and looking at some of the events leading to it.
Founded in 2018, Celsius Network’s’ business consists of cryptocurrency-related financial services through which retail and institutional investors can earn rewards on cryptocurrency transferred to Celsius, send, receive and store cryptocurrency, and borrow in “fiat” currency using cryptocurrency as collateral.
According to information provided by U.S. lawyers, Celsius also operates one of the largest crypto-mining enterprises in the United States.
As of the petition date, Celsius employs about 370 employees and independent contractors across about 14 countries, with roughly 285 in the United States. In July, Celsius had approximately 1.7 million registered users on its platform and $6 billion in assets. Celsius closed Series B equity funding with a capital raise of approximately $600 million from various investors at an implied enterprise value of $3 billion in 2021, and by May 2022 it raised approximately $690 million from Series B financing.
Mashinsky explains that after “early success the amount of digital assets on the Company’s platform grew faster than the Company was prepared to deploy.” This caused the company to make “what, in hindsight, proved to be certain poor asset deployment decisions,” some of which Mashinsky says “took time to unwind” and “left the Company with disproportional liabilities when measured against the unprecedented market declines.” Despite the company’s efforts to unwind these asset deployments, “unfortunately, the damage was done,” says Mashinsky.
The declaration describes “other unanticipated losses,” including a private lender’s inability to return the company’s collateral when Celsius attempted to repay a loan in July 2021. According to the declaration, this resulted in the company holding an uncollateralized claim against its lender in the amount of about $509 million after setting off its own loan obligations. This lender has been making regular principal payments to the company since September 2021 in an amount “in excess of $5 million per month,” says Mashinsky, adding that the aggregate remaining principal balance is “approximately $439 million, consisting of $361 million in USD and 3,765 BTC, the latter worth approximately $78 million.”
The company took other steps in 2021 and 2022 to address its losses, including by reducing user rewards rates, imposing new user fees and borrowing “stablecoins to fund purchases of crypto to align the magnitude of crypto assets with crypto liabilities.” The right-sizing efforts, which Mashinsky says put the company on a “trajectory” to stabilising the business, were interrupted by “unanticipated global events,” including the “lingering effects” of the COVID-19 pandemic, inflation and the war in Ukraine, which Mashinsky says led to “extreme” crypto market volatility “particularly in the last three months.”
The crypto crisis “led to growing industry-wide reluctance to do business” with cryptocurrency firms such as Celsius, Mashinsky continues, adding that “users began withdrawing crypto from Celsius’ platform in large amounts and at a rapid pace.” Mashinsky explains that the Luna fallout and “false and misleading” negative media attention caused Celsius users to withdraw over $1 billion from the platform over five days in May 2022, “at a time when distrust of cryptocurrency was at an all-time high.”
Celsius became unable to meet user withdrawals, says the declaration, because its business model depends on deploying digital assets to produce income, which “lock” up such assets.
In May and June 2022, the declaration continues, the company made the “difficult decision” to forgo providing additional collateral to one of its lenders, Tether, issuer of stablecoin USDT, and agreed to an “orderly liquidation” of its outstanding $841 million USDT loan after Tether issued a margin call. Celsius agreed to liquidate its Tether loan to “preserve the remaining collateral in excess of the value of the loan,” says Mashinsky, which resulted in a loss of approximately $97 million.
All of this led to an “unexpected and rapid run on the bank,’” says the declaration, which caused the company’s June 12 “pause” on all withdrawals, swaps and transfers on its platform. Mashinsky says the company imposed the pause to “protect its users” by preventing “those [users] who were the first to act” from being paid in full while “leaving other users behind to wait for Celsius to harvest value from illiquid or longer-term asset deployment activities.”
Concurrently with the “pause,” the company decided to “limit its engagement in asset deployment” to “conserve its remaining assets” and to hire restructuring advisors. Mashinsky states that the company has “unwound nearly all of its outstanding” DeFi loans “and other counterparty loans to bring its collateral back under its control.”
Initial discussions with potential third-party investors “suggested that an in-court process would be necessary to yield the most value-maximising path forward and to allow Celsius to return value to users in a fair and transparent manner,” says the declaration.
On or around June 19, the debtors formed a special committee, and on June 30 installed disinterested directors Alan Carr and David Michael Barse. The special committee is vested with authority to evaluate, negotiate and approve any “possible transactions.”
The declaration also explains that “in addition to its lending services and revenue generated by [m]ining, Celsius engages in other asset deployment activities to generate a ‘sufficient yield.’” These activities include the deployment of digital assets into automated market makers or lending protocols for a fee and the borrowing of USD as stablecoins from DeFi protocols collateralized by digital assets. These “DeFi loans” are governed by “smart contracts” that are self-executing on the blockchain and are typically overcollateralized. If the value of posted digital collateral securing the debtors’ borrowings falls below a certain threshold, the DeFi protocol will automatically liquidate the collateral and close out the loan.
As of June 27, Celsius discloses $648 million in “DeFi borrows” or borrowings by the debtors, collateralized by approximately $1.61 billion in digital assets. Celsius indicates that it used these DeFi loans to finance its operations. These DeFi loans were held on four different DeFi protocols:
- Maker (MKR) ($225 million loan collateralized by $499 million in digital assets);
- AAVE ($263 million loan collateralized by $708 million in digital assets);
- Compound ($157 million loan collateralized by $409 million in digital assets); and
- Notional Finance ($3.2 million loan collateralized by $6.6 million in digital assets).
However, as of the petition date, substantially all of these DeFi loans were repaid by the company, and the collateral was returned.
Celsius’ engagement in other exchange deployments
Celsius describes five other “exchange deployments” that were overall intended to be market neutral:
- Cash and Carry, where Celsius leveraged demand in the futures markets to benefit from the funding costs that long futures holders were willing to pay short holders;
- Market Making, where Celsius held both long and short futures positions in a manner that allowed it to benefit from “inefficiencies in the futures market”;
- Swing Trading, where Celsius held both long and short futures positions, but with “an imbalance between the amount of long and short options Celsius held.” This allowed Celsius to benefit from its experience being an active participant in the futures market. Since this trading activity was not market neutral, Celsius had set narrow risk limits on such activity which were also accompanied by strict stop-loss mechanisms;
- Funding, where Celsius used the funding markets that exist in several exchanges, allowing users of such exchanges to borrow different digital assets from Celsius’ account on such exchange, to be used for trading on the same exchange, paying Celsius a financing fee; and
- Spot Trading, where Celsius kept a portion of the assets on exchanges to be ready for immediate spot transactions between one digital asset and another, where this was needed to balance its assets versus liabilities, to prevent cross-currency exposure. This was a hedging strategy rather than an income-generating activity.
Celsius notes that it maintains limited exchange deployments in certain futures but does not intend to engage in any exchange deployments in the near term.
The debtors’ list of 50 largest unsecured creditors is led by Pharos USD Fund SP with an $81.1 million loan claim and also includes Sam Bankman-Fried’s firm, Alameda Ventures Ltd. Bloomberg reported earlier today that Pharos may be affiliated with Alameda and Sam Bankman-Fried. In addition to the top 10 named creditors listed in the chart below, the debtors’ list of largest unsecured creditors includes 40 unnamed creditors with customer or loan party claims ranging from $5.6 million to $40.6 million.