On Crypto Lending And the Celsius Saga

In this article, we take a closer look at the field of crypto lending, how one of the biggest lending protocols collapsed in a matter of months and what we can learn from it.

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@enter.artPUBLISHED 17TH JULY 2022

Written by Chidera Anushiem

The COVID-19 pandemic had a negative impact on the returns from traditional investment instruments such as stocks, gold, and real estate, driving investors to flock to cryptocurrency. Individuals and institutionalized investors alike have tried their luck in the industry, which has produced decent returns even during the global economic downturn, which has alarmed many investors. 

Despite the fact that there is an intense debate raging about cryptocurrency offering a great window to grow wealth quickly — and its extremely volatile nature — there is no denying that the industry has grown rapidly over the last two years. It is still innovating, experimenting with new ideas and breaking down more barriers in the process. 

One of these experiments birthed an idea that has further lowered the barrier for entry (or success?) in crypto: crypto lending. Crypto lending is far from the most innovative value propositions of CEXs and DEXs — and indeed the crypto space — but it is one that transcends its time, not only by demolishing the enormous power that traditional financial institutions wield over credit and financing, but also by giving small business owners all over the world a real chance to achieve milestones that lack of funds prevents them from reaching. Against this backdrop, let us now delve into the crux of this article. 

What is crypto lending?

Crypto lending is an ingenious tool that allows users to quickly obtain the funds they require, as it allows them to use their crypto holdings as collateral for securing loans. If you're wondering how to borrow cryptocurrency, collateralized crypto lending is an option. Borrowers can use their cryptocurrency assets as collateral to obtain a fiat or stablecoin loan. 

This allows you to obtain the funds without having to sell your coins, use the funds to achieve your goals, and then repay to regain control of your assets. Crypto loans enable you to generate returns from your digital assets by lending out a portion or all of your holdings.

Crypto lending platforms are crucial in the distribution of such loans. You can generally borrow up to 50% of the value of your digital assets, though some platforms may allow you to borrow more. In general, crypto loans do not have a concept like Electronic Money Institutions (EMI), and borrowers may repay whenever they can before the fixed term expires. 

The answer to the question of whether lending cryptocurrency is profitable is dependent on a number of factors. You lose your assets if you default on your debts. Inconsistencies inherent in crypto assets have led more people into stablecoin lending, as that offers greater stability. There is also the question of platforms and the return on investment (ROI) they offer to lenders. Stablecoin lenders on lending platforms such as Nexo can earn 8%, while on Compound Finance — a decentralized crypto lending platform — the lending annual percentage rate (APR) for Dai (DAI) and USD Coin (USDC) is 12% and 9%, respectively.

What Does Crypto Lending Entail?

A cryptocurrency-backed loan, like a securities-based loan, uses digital currency as collateral. It is similar to a mortgage loan in many ways. You use your crypto assets to obtain the loan and repay it over a set period of time. These loans are available through a crypto lending platform or a crypto exchange. Though you retain ownership of the collateralized crypto, you lose the ability to conduct transactions with digital coins.

Crypto loans appear to be a viable option due to several benefits such as low interest rates, no credit check, loan currency selection, quick funding, and the ability to earn passive income on your crypto that would otherwise be idle. Furthermore, on several crypto platforms, you can lend your own digital coins and earn a high APY (sometimes more than 10%).

There are two distinct parties in all crypto lending transactions: the borrower and the lender. The borrower must deposit crypto assets as collateral to secure the lender's loan. The arrangement benefits both parties because the borrower receives an immediate loan in exchange for their crypto assets, while the lenders earn interest on the loan amount. If the borrower defaults, the underlying crypto assets are sold to recover their money. Against this backdrop, let us examine the downfall of Celsius, and what lessons we can learn from the fiasco. 

From Boiling Point to Liquidation: The Dark Clouds Before The Storm

Celsius Network, founded in 2017, is a platform that lets its users take and grant loans to other users in cryptocurrencies. The network was founded by Daniel Leon and Alex Mashinsky, two top Israeli crypto executives, and was registered in the UK. In 2018, the company carried out its initial coin offering (ICO) and released its CEL token to the crypto ecosystem. 

Celsius' tagline is: "An economy where financial freedom doesn't come with a price tag." Although this slogan was a powerful marketing tool — and many had their doubts — it was truly effective for a few years. Since it began operations 5 years ago, the company grossed over $25 billion in transactions and loans until June 12, when it announced that it was pausing withdrawals. 

However, the signs of mismanagement of funds were always visible prior to the collapse. Towards the end of 2020, during the BadgerDAO hack, Celsius was the largest victim of the attack, losing over $50 million in crypto assets. To compensate the victims of this attack, BadgerDAO created the remBADGER token. 

BadgerDAO then assured investors that it would pay out the rest of the losses in remBADGER over the next two years. However, there was a proviso: the remBADGER tokens must remain in the Badger vault. If the tokens were withdrawn, future compensations would be forfeited. Surprisingly however, on March 18, 2022, Celsius took out all of its remBADGER tokens. The tokens were worth over $2 million at the time of withdrawal. 

When Celsius Network recognized its error, it attempted to persuade the Badger team to waive the requirements outlined by the BIP-80 resolution in order to make a new deposit. Unfortunately for Celsius, the BadgerDAO took seriously the idea that the "code is law" and the proposal was defeated. 

The firm's management has also raised concerns among many users. In November 2021, money laundering charges were brought against Celsius's chief revenue officer Roni Cohen-Pavon and chief financial officer Yaron Shalem.

When the Terra scandal unfolded on May 11, 2022, some skeptics started to look into Celsius. Investors had faulted the Celsius team for ‘doing nothing’ while the value of the tokens dropped as a result of the Terra debacle. Celsius ($CEL) experienced a 90% decline from its all-time high of $8.05 to $0.82 on May 20, 2022. According to several Celsius users, the platform sold off their shares when $CEL fell. As the price dropped, increasing their losses, they claimed that trade was illiquid. 

Fortunately, Celsius has set itself on the (long) path to redemption. On June 15, Celsius hired restructuring lawyers to help ease its financial troubles. Sensing the urgency of the matter, on July 12, they hired a different firm to steer it out of murky waters. 

On July 13, the lending platform announced on Twitter that it had filed for bankruptcy, allowing it access to a $167 million liquidity injection.  

The trouble with High APY Projects

Celsius was one of the fastest-growing institutions in the crypto market. Celsius had over 800 employees at the time of the collapse, and that number had grown by more than 200% in the previous year alone. The issue is that crypto is currently in a bear market, and for businesses to continue operating properly, they must maintain liquidity. As most institutions and retail investors sell off their cryptocurrencies, liquidity becomes a major concern for these high-yield projects, causing them to run into problems. 

Talking Points From Celsius’ Downfall From Boiling Point to Zero 

As an attendant consequence of Celsius’ crumble, there is understandable skepticism within the DeFi ecosystem. Worse still, the collapse of yet another lending platform, Vauld, throws the lending sector of DeFi into the spotlight. But what are the most important talking points from these events? 

#1. Not Your Keys? Not your Coins 

In the field of cryptocurrencies, the saying "Not your keys, not your coins" is used to emphasize the importance of possessing the private keys linked to your assets. The owner of the private key controls how the related crypto assets are used. Without the private key, crypto owners simply entrust a third party to keep their coins secure on their behalf. Stories like the Celsius one serve as a chilling reminder that these third parties frequently operate against their clients' best interests. 

On the flip side, although the common conclusion from this narrative has been that individuals should control their own crypto, others, including Sung Hun Kim, CEO of Metaverse World, have argued that centralized platforms like Celsius are the real culprits.

In an interview, he said: "When discussing security issues, it is less about how and more about why. Both centralized and decentralized structures are not impregnable, however, Celsius being inherently closed-circuit affects the right of the customer to assess the growing risk. It is not about who stores the keys, but the level of transparency a project is willing to provide."

#2. Can Regulation Save Crypto From Future Collapses?

As is the case now, there have been calls for regulation in the past bear markets— although these glamours have not yielded much. However, it appears that things might be different this time. After the Terra fiasco, which resulted in the loss of millions of dollars in investor funds, several powerful individuals and organizations appear to be paying serious attention to the crypto market. In the light of NFT platform hacks, phishing attacks, and pump-and-dump schemes, it is likely that this attention will metamorphose into serious action. 

Regulators will probably try to impose restrictions on anything they consider to be too dangerous. A recent instance of this was when the SEC turned down Grayscale's attempt to start a Bitcoin spot ETF. The SEC explained its choice by stating that it was worried Greyscale had not addressed concerns about market manipulation. 

Given the alarming effects of the bear market, it appears inevitable that more regulation will soon be implemented. It is then left to be seen if such moves will aid the market in eliminating the riskier platforms that expose their users to manipulation and other systemic and institutional vulnerabilities. If that occurs, it might spark a fresh swell of hope and confidence in the cryptocurrency industry.

#3. The Projects’ Perspective: Solving The Question of Liquidity 

All the lessons learnt over the previous century in the traditional banking system are now being witnessed by the crypto ecosystem. Cryptocurrency markets will inevitably become cyclical — just like conventional markets — as the ecosystem develops. Projects must apply lessons from the past to survive the downturn. This does not imply that cryptocurrency will lose its competitive edge; it just means that a relatively nascent sector like crypto will benefit from smart sustainability standards. 

The failure of massive projects like Terra and Celsius has a cascade effect on the market as shown by the sharp decline in the values of most cryptocurrencies. Investor sentiment will inevitably turn overwhelmingly negative among retail and institutional investors, although a nice twist could be that the market sees further declines as key players sell and more liquidations occur (Vice versa). Fortunately, the selling pressure on staked Ethereum (stETH) is likely to increase, making cheaper stETH available in second-hand markets, causing an increase in demand among new investors, which in turn causes an increase in demand and drives prices higher. This would be a nice twist, albeit the chances are slim. 

Ultimately, the issue of liquidity is the most crucial. The increasing popular ethos that prioritizes quick user growth at all costs is unsustainable. Offering excessive staking rewards for even the most routine tasks would inevitably result in a system outage, whether it be in traditional banking or cryptocurrency. When the cycle turns again, the enterprises that creatively apply these conventional financial precepts will be best positioned to seize fresh development possibilities. For now, however, we can only hope that lessons are being learnt.  

This article is written by Chidera Anushiem as a part of enter.blog's bounty program. Do you have an interesting topic, series or subject you think would be fitting for enter.blog? 

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