Bankrupt Crypto Lender Celsius Could Leave Customers Last In Line To Get Paid

What Happened

Earlier this month, crypto lender Celsius Network filed for Chapter 11 bankruptcy protection in federal court the Southern District of New York. The filing was not a surprise to many familiar with the company’s recent news, as it had been more than a month since Celsius halted customer withdrawals due to self-reported and self-described “extreme market conditions.” What alarmed many in the industry, especially Celsius users, is the way the company will likely treat the frozen funds.

In the court filing, Celsius’ Chief Executive Officer Alex Mashinsky disclosed a roughly $1.2 billion hole in the company’s balance sheet. As of July 13, 2022, the company had $5.5 billion in total liabilities and $4.3 billion in assets. Celsius said it owes consumer users (as opposed to institutional partners) more than $4.7 billion.

A financially distressed company can choose between a few different types of bankruptcy proceedings. Celsius chose Chapter 11, which generally prioritizes repayments to secured creditors first, then unsecured creditors, and finally equity holders. Unsecured creditors are most likely to be individuals or institutions that lent money without obtaining specified assets as collateral, or “security”, to protect their loan.

While it is unclear how Celsius and the bankruptcy court will classify Celsius users that have been prevented from accessing their funds, Celsius’ terms of service and court papers seem to indicate users will be treated as unsecured creditors. This begs the question of when and if Celsius’ customers will be able to recoup some or any of their losses. This may well be the subject of heated litigation in the bankruptcy court.

Key Actors

● Celsius Network

● CEO Alex Mashinsky

Context

Celsius Claimed To Be As Safe As A Bank

Celsius held itself out as a safe alternative to traditional banks and promised users high interest rates. Customers could use their credit cards or bank accounts to buy crypto assets. To entice customers to stake their cryptocurrency with Celsius, the company promised returns of up to 20% on deposits, including 8.8% on stablecoins like Tether’s USDT.

Mr. Mashinsky consistently downplayed risks entailed by these strategies and called initial allegations that the company was having issues as “Fud” (“fear, uncertainty and doubt”).

Many Celsius customers have written to the Bankruptcy Court, arguing to get access to their funds and saying they felt lied to by the company and Alex Mashinsky.

“I watched every single AMA (Ask me Anything) each Friday since sign-up, and week in and week out Alex would talk about how Celsius is safer than banks because they supposedly don’t rehypothecate and use fractional reserve lending like the banks do,” says Stephen Richardson.

Another Celsius user, Brian Kasper, said “Celsius continued to tell people they were better than a bank. Safer, with better returns. As well as tell us they had billions in liquid cash.”

Despite Celsius only recently filing for bankruptcy, questions about its risk management procedures had been circulating for years. For instance, in June 2021, Crypto Custodian Prime Trust cut ties with Celsius after its risk team expressed concern about Celsius’ strategy of “endlessly re-hypothecating assets.” Since March 2020, Celsius had been using Prime Trust to store assets for some of its customers.

As Scott Purcell, founder of Prime Trust and Fortress.xyz, told me, “In 2020 I took a long look at Celsius and other lending/staking platforms out of professional curiosity. The more I learned about their business models, the more concerned I became. I researched how they were paying such high interest rates. I can certainly understand getting a premium for doing something that banks were shying away from. I also understand lending (hypothecating)…