Why crypto lender Celsius Network halted withdrawals

The crypto-lending firm Celsius Network halted withdrawals and transfers, amid an apparent liquidity crisis, as the price of Bitcoin plunged to pre-pandemic levels.

Celsius, which promises high-yield returns on customer deposits, appears to be the latest crypto company to buckle under tightening financial conditions. It comes just one month after the collapse of the Terra-Luna stablecoin network.

Celsius operates like an unregulated bank, enticing customers with staggeringly rates for deposits of cryptocurrencies, and then loaning out those deposits to other customers. Celsius says its loans are collateralized in Bitcoin (though not all of them are), and there is no assurance it can pay out customers in the event of a rush of withdrawals, especially since Bitcoin’s price has fallen 40% in the last year.

The company’s co-founder and CEO Alex Mashinsky has spent years decrying critics for spreading “FUD” — or, “fear, uncertainty, and doubt” — about Celsius Network’s liquidity.

“Mike do you know even one person who has a problem withdrawing from Celsius?” Mashinsky asked venture capitalist Mike Dudas on Twitter on June 11. “Why spread FUD and misinformation.”

The next day, on June 12, Celsius halted withdrawals, citing “extreme market conditions.” CEL, a coin issued by Celsius, has fallen 32% since then.

What is Celsius Network?

Celsius Network is a large, venture capital-backed cryptocurrency firm, which was valued at $4.1 billion after its most recent Series B funding round in November 2021, according to PitchBook. Since November, however, the total crypto market has shed more than 60% of its value, losing $1.6 trillion in market capitalization, according to CoinMarketCap.

Celsius offers customers a 17% annual yield on deposits, a shocking proposition compared to traditional banks which, on average in the US, currently offer a 0.07% annual yield for savings accounts, according to the Federal Deposit Insurance Corporation (FDIC).

Crypto lenders like Celsius are not regulated like traditional banks and do not have basic protections like deposit insurance, which has been a staple of US banking regulation since the FDIC was established in 1933 following the Great Depression.

“The crypto industry is again and again learning all of the old lessons from traditional finance,” said Todd Phillips, a former FDIC lawyer who is now the director of financial regulation and corporate governance at the Center for American Progress, a liberal think tank. “It’s sad because if we just paid attention to the past, a lot of the harms here and losses could have been prevented.”

Regulating crypto lenders

Celsius is only the latest in a string of failures in crypto lending, and it’s clear that these firms require basic regulations to protect their customers.

In 2020, the crypto lender Cred went bankrupt after reportedly taking out bad loans. The stablecoin TerraUSD and its sister coin Luna fell apart in May 2022 after customers made massive withdrawals on the Anchor Protocol, which similarly offered 20% yields to customers.

But the greatest harbinger of Celsius’ struggles is its closest competition. BlockFi, a popular crypto lender that advertised 9% annual yields, settled for $100 million with the US Securities and Exchange Commission (SEC) in February 2022 and vowed to register its interest account product as a security. 1 In a statement, SEC enforcement director Gurbir Grewal warned BlockFi’s peers to “take immediate notice.”

Crypto lenders might operate like banks, but their loans can also qualify as securities under federal law if they pass the Howey test, a four-part rubric from a 1946 Supreme Court case, said Lee Reiners, the executive director of the Global Financial Markets Center at the Duke University School of Law. In order to qualify as an “investment contract” under federal law, a financial product would require (1) an “investment of money” in (2) a “common enterprise” with (3) a “reasonable expectation of profit” that (4) comes from the “efforts of others.”

The popular crypto exchange Coinbase halted its planned crypto-lending product in 2021 following legal threats from the SEC. Similarly, Celsius has received cease and desist letters from four US states — Texas, New Jersey, Alabama, and Kentucky — alleging they are unregistered securities. So far, there has been no federal action against Celsius, but that may be coming soon.

“I’d imagine some SEC subpoenas are coming if they haven’t already arrived,” said Lee Reiners, the executive director of the Global Financial Markets Center at the Duke University School of Law. “I fully expect some enforcement actions taken not only by the SEC but by state securities regulators as well.”

“Celsius is about to be inundated with subpoenas and enforcement actions,” he added. “This is just the early stages for this story.”

Celsius is hurting the broader crypto market

Celsius’s decision is rippling throughout the ailing crypto market. On June 13, the crypto exchange Binance halted bitcoin withdrawals on the heels of the Celsius news, and the prices of Bitcoin and Ether fell 11% and 13% respectively in the past day amid an industry-wide sell-off. The crypto crash is likely correlated with that of the traditional stock market, as the S&P 500 opened in bear market territory on June 13. While BlockFi announced it is laying off 20% of its staff on June 13, rival firm Nexo offered to buy out Celsius.

“We are in a crypto winter,” Phillips said. “Without regulation, companies tend to only have rosy forecasts of the future and only expect that asset values will keep going up. Regulations help ensure that they plan for the future when asset values go down. Because a lot of these things haven’t been regulated, I predict we’ll see a lot more blowups.”

Reiners paraphrased Warren Buffet: “When the tide goes out, you see who’s swimming naked.”

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