Six years ago, in 2017, Alex Mashinsky, Daniel Leon and Nuke Goldstein founded Celcius Network, a cryptocurrency-based financial institution that promised to capitalise on the decentralisation of the financial system that cryptocurrency offered and pass on the said benefits to its clients. Indeed, the main product the company ‘sold’ to its clients can be described as a general distrust of the conventional brick-and-mortar banking system. Celsius’ former CEO and key salesman provided grounds for this mistrust, arguing that ‘banks are not your friends’, and that banks took the lion’s share of the yield of their client’s deposits. Celsius promised to change this way of doing business, saying that they would only retain 20% of what their client’s money made, essentially paying out 80% of their profits. They also refrained from charging clients for their services, instead facilitating transactions and administering client deposits completely for free. The business model was very attractive to new depositors, as Mashinsky seemed to have a viable business plan to sustainably offer what was effectively a high-yield savings account for cryptocurrency outside of the traditional financial system.
No red flags raised
In hindsight, most people wonder why Celcius’ promise to offer a yield of 8% at a time when the more well-established, conventional banking system was only offering about 1% should have had most people’s alarm bells ringing. Mashinsky made the offer seem convincing, however, detailing the numerous ways in which Celcius would earn its high yields while describing the banks as essentially robbing their clients of their money. For one, Celsius would earn revenue through token sales, through lending at high interests, bitcoin mining and through the crypto trade. Added to this was, of course, the fact that most people had no real idea of what the standard yield on crypto could be – by 2021, crypto had become the main focus of retail investors weathering the pandemic at home and had become inflated beyond all proportions. Besides, other crypto trading ventures also offered comparable rates (close to, or even higher than Celcius’ 8%).
Above all else, Celsius guaranteed that their business model was far more conservative than anything else on the market. According to CEO Mashinsky, Celsius required a collateral of 200% to lend out money. The company also promised its clients that the ‘bank’ kept billions more in liquidity to ensure that a bank run could never occur. For those unfamiliar with the term, a bank run is when a number of people withdraw their deposits from a financial institution in fear of an impending liquidity crisis in that institution. As the fear spreads and more and more people withdraw their deposits, a liquidity crisis becomes unavoidable. Celsius was positive that there was no possibility of this ever happening in their bank – and yet that’s exactly what happened.
So how did Mashinsky’s foolproof plan fail? Was it gross incompetence, or had there been criminal intent to embezzle depositor money?
On top of the world, looking down on creation – and rock bottom
The cryptocurrency boom by the end of 2021 meant that Celcius was practically on top of the world at that point. Headquartered in New Jersey, Celsius maintained its offices in four countries and has become a global operation. As of May 2022, the company had lent out $8 billion to its clients and boasted $12 billion in assets under its management. By June, it had halted all operations citing unforeseen extreme market conditions. On 7 July 2022, former Celcius investment manager Jason Stone sued Celcius for operating a ‘Ponzi scheme’, which Celcius countered by suing him in August, saying that he had embezzled millions of dollars worth of cryptocurrency from the firm. The lawsuit and counter-lawsuit finally gave the justice system the opportunity to peer into the inner workings of the company and establish what had actually happened to the money.
Accordingly, the court appointed an independent examiner as a fact finder on behalf of the state, and their reports shed light on how Celcius really paid out such astonishingly high yields on their deposits. For one, the report established that Celcius never paid out 80% of the profits it made on its deposits to its depositors because Celcius made little to no profit on the assets it managed. The report also showed that the organisation also made no effort to adjust its rewards programme or the ‘interest’ it paid out according to the yield it did earn on its crypto deposits. Instead, Mashinsky doubled down on his promise to the public that his ‘bank’ would pay 8% (and higher) interest on their deposits. In fact, the reports of the court-appointed officer even stated that there was evidence that Mashinsky had overridden the recommendations of the company’s executives to lower the rewards they were offering.
Where did the money come from, and where was it going?
This of course naturally begs the question – where was the money for the rewards coming from? Since the company was making little profit and the rewards scheme was not being adjusted to reflect this state of affairs, it naturally follows that the company would have been operating under a deficit in cash. That there was a deficit is manifest of course – when the company finally filed for Chapter 11 bankruptcy on 13th July 2022, the company recorded a $1.2 billion deficit in its balance sheets. The court-appointed examiner established just how the company had managed to maintain its improbably high rewards schemes – as high as 17% yield in some cases.
For one, CEO Mashinsky’s promise that Celcius’ business model was extremely conservative was found to be a lie. It was found that the firm had offered unsecured loans with little to no collateral in the interest of earning high yields on its money. The firm had been forced to make these risky investments to meet the rewards scheme that it promised the public because much of the money that ought to have been with the company in the form of depositor funds had by then disappeared into what had been marketed as the company’s guaranteed revenue earning scheme – ‘the flywheel’.
The Flywheel
From the beginning, holding CEL tokens, Celsius’ own crypto token, had formed an important part of the rewards scheme that the company offered. The more CEL tokens depositors held in their wallets, the higher they climbed on the rewards ladder, effectively earning more and more on their deposits. This was described by the CEO as a self-sustaining ecosystem for the token, as there would always be an incentive to buy CEL, as well as a guaranteed market for those who wished to divest. On its own part, Celsius also gave its own guarantee that the company would step into buy CEL at market value should anyone – or everyone, want to divest, thereby ensuring that there could be no way in which depositors would lose out.
There were, however, a few issues with this supposedly foolproof plan.
For one, Celsius did carry out its promise of buying CEL tokens to maintain a stable market for those who had chosen to invest in it. However, since the company did not earn significant revenue to do so at the levels that were required of it, Celsius went about purchasing CEL using depositor funds. The depositors themselves, who had only agreed to have their funds directed towards bona fide investments, had no idea that their funds were being redirected in this manner. The company’s breach of trust did not end here, as there was another element to the deception that was being carried out – the single largest holder of CEL tokens was none other than Mashinsky himself.
The artificial demand for CEL that was thus being created at the expense of customer deposits was therefore funding the divestments of none other than the CEO of the company himself. At the time of the court-mandated officer’s report, it was estimated that Mashinsky had realised $68.7 million worth of CEL – at the expense of the people who had entrusted him with their money. Co-founder Daniel Leon was said to have realised $9.74 million. This cycle of alleged embezzlement was being funded by depositors, which meant that when depositor money ran out, the company relied on new depositors to keep funding these activities – hence former investment manager Stone’s description of the company’s activities as a ponzi scheme.
The fallout
These actions, which overrode the advice of the experts in the company’s pay, suggest that Celcius’ bankruptcy is not the result of gross negligence, but rather a deliberate result of a series of decisions that intended to defraud its clients of their money. Mashinsky himself was arrested in July this year as a result of a joint decision by the consumer-protection body, the Department of Justice and the SEC. However, he has since been released on a bond valued at $40 million and a court order to have his banking and real estate assets frozen. He had stepped down as CEO from Celcius in September last year, and the company’s hapless creditors are now left with the mammoth task of reorganising the company. Accordingly, the latest media reports show that these creditors had voted their approval for a reorganising plan that was set to see 67%-85% of their cash returned to them, late this September. These reorganising plans have been forwarded by company restructuring specialist Stretto and are now awaiting final approval from the court.
According to observers, Celcius’s fall is yet another testament to the fallacy of decentralisation that cryptocurrency has become. Organisations like Celcius claim to offer a path to decentralised finances when in reality, they are extremely centralised entities which control the flow of crypto assets, as evidenced by the manner in which Mashinsky alone was able to dictate how the funds the company held were used. The collapse also speaks to the importance of deposit insurance in financial institutions, which is yet to be regulated by any governing body in the crypto space. As Celcius agreed to no form of depositor insurance prior to accepting funds, no entity, even a state institution, is obligated to compensate for the losses suffered by Celcius’ depositors. Celcius is not even under the obligation to prioritise these clients over their ordinary shareholders, should the company be liquidated. The Justice Department for its part, has entered into a non-prosecution agreement with Celcius, which should mean that no criminal charges should be forthcoming. This agreement, however, is dependent on the company accepting responsibility for the schemes alleged in the court examiner’s report and pledging to continue cooperation with the authorities in their investigations.
(Theruni Liyanage)