The Celsius Debacle: What Went Wrong

The crypto space, already reeling from poor macro conditions and the Terra collapse, might be in store for some more pain.

On June 12th, Celsius, a leader among Centralized DeFi (CeDeFi) companies, paused all withdrawals, swaps, and transfers between accounts, sparking fears that they are insolvent.

In this segment, we’ll be talking about what Celsius is, what went wrong, and what the implications of it going under would be.

An Overview of Celsius

There is a large population of people attracted to the yields in DeFi, but don’t know how to go about obtaining it. This is where CeDeFi companies come into play, and they have recently exploded in popularity.

What is a CeDeFi company? In essence, it is a crypto bank. These companies take users’ money and deposit it into DeFi, earning customers a yield while pocketing some for themselves. This has turned into quite a lucrative business, with major players Nexo, BlockFi, and Celsius all receiving valuations over $1 billion.

Even though CeDeFi companies have not been immune to the hard times currently affecting us all, Celsius still had $12 billion in assets under management as of May. Although that is down from a high of $24 billion in December, it is still a significant amount by any means, and does not on its own point to a company bordering on insolvency.

Naturally, this all leads to the question of “what went wrong”?

A Chain of Unfortunate Events

As most people in crypto know, DeFi yields are great but risky. During a bull run, it can feel like you are printing money at will. Double and even triple digit Annual Percentage Yields (APYs) are a dime a dozen. However, during a bear market, these opportunities dry up considerably. Combine that with the inherent risks of hacks and smart contract failures in DeFi, and it’s easy to see how, without the utmost care, a fund can lose money very quickly.

Unfortunately, it looks like Celsius has learned this the hard way.

To start, Celsius has lost hundreds of millions of dollars in hacks and protocol failures. Although not deadly by themselves, it is definitely not ideal.

Next, Celsius had exposure to the Terra debacle. Anchor protocol on Terra promised 20% APY on UST stablecoins. This is a really attractive yield, which showed through the $20 billion of capital locked in the protocol before its collapse. It appears that Celsius was also allured by the yield in Anchor, reportedly to the tune of $500 million.

Finally, Celsius is currently facing a liquidity crisis.

A core source of yield for Celsius has been stETH deposits in Lido. For those unaware, Lido is an Ethereum liquid staking protocol. Users deposit ETH and get back stETH, which then earns interest from the deposited ETH. Although stETH is fully backed, as each stETH is minted from 1 ETH, it is also illiquid, as users can not redeem their stETH for ETH until the Ethereum Merge later this year.

Until recently, this has not been a problem, as the stETH<->ETH Liquidity Pool on Curve has facilitated smooth transfers, ensuring that 1 stETH is redeemable for 1 ETH. However, because the bear market has forced people to sell assets in search of liquidity, this pool has recently become imbalanced, with stETH now composing 78% of the pool. Because there is much more stETH than ETH in the pool, stETH now trades at a discount to ETH, with 1 stETH only worth 0.9528 ETH at the time of this writing.

This is bad news for Celsius. In good times when everyone wants to deposit money, their massive stETH position ($500 million worth) earns a steady and considerable yield. However, during these tough times when everyone wants to withdraw, this illiquid position just becomes a liability. Because Celsius has ~300k more stETH than ETH in the Curve pool, it is going to be almost impossible for them to sell their position. Even if they are able to, they will have to deal with massive slippage, meaning that they are going to have to eat millions of dollars in losses. A bad situation any way you slice it.

However, the bad news for Celsius doesn’t end with stETH. Celsius has also used MakerDAO to take out a loan on their $532 million WBTC (Wrapped Bitcoin) position. This debt is currently a massive $235 million, and should bitcoin fall to ~$15k, this position will be liquidated, which would result in devastating losses for Celsius depositors.

Ultimately, the ills currently afflicting Celsius can be explained from bull-market greed, poor risk management, and overexposure to illiquid positions.

The Implications

One of the really sad things about the Terra collapse was that it affected a bunch of regular people. It burned a lot of people new to the space just trying to earn a steady yield, which is really what DeFi’s about.

A collapse for Celsius would affect many of the same people.

People who use services like Celsius aren’t the traditional crypto gambler looking to make it rich quick. They are people who are much further down the risk curve, and just want to safely earn yields higher than the horrendous rates that a savings account gives.

Attracting these people to crypto is super important for the future of the space, and will likely determine if it is able to evolve past its current iteration and into something more mainstream and appealing to the general public.

If Celsius were to go under, however, the damage to the reputation of crypto would be immeasurable. If people feel like they can’t trust a ‘safe’ service like Celsius, it’s going to be awfully difficult to get them to use DeFi in its entirety.

That’s not even mentioning the potential regulatory ramifications, which are sure to come should Celsius ultimately goes under.

Celsius is in trouble, and by extension, they have endangered both the money of all of their users and the future of crypto as a whole. Should they survive, let us hope that they learn from this and make better decisions in the future. We would all be much better off for it.