From $25 billion to $167 million: How a major crypto lender collapsed and dragged many investors down with it

Celsius filing for bankruptcy this week surprised virtually no one. Once a platform freezes customer assets, it's typically all over. But just because the fall of this embattled crypto lender didn't come as a shock, doesn't mean it wasn't a really big deal for the industry.

In October 2021, CEO Alex Mashinsky said the crypto lender had $25 billion in assets under management. Even as recently as May — despite crashing cryptocurrency prices — the lender was managing about $11.8 billion in assets, according to its website. The firm had another $8 billion in client loans, making it one of the world's biggest names in crypto lending.

Now, Celsius is down to $167 million "in cash on hand," which it says will provide "ample liquidity" to support operations during the restructuring process.

Meanwhile, Celsius owes its users around $4.7 billion, according to its bankruptcy filing — and there's an approximate $1.2 billion hole in its balance sheet.

It goes to show that leverage is one hell of a drug, but the moment you suck out all that liquidity, it's a whole lot harder to keep the party going.

The fall of Celsius marks the third major bankruptcy in the crypto ecosystem in two weeks, and it is being billed as crypto's Lehman Brothers moment — comparing the contagion effect of a failed crypto lender to the fall of a major Wall Street bank that ultimately foretold the 2008 mortgage debt and financial crisis.

Regardless of whether the Celsius implosion portends a larger collapse of the greater crypto ecosystem, the days of customers collecting double-digit annual returns are over. For Celsius, promising those big yields as a means to onboard new users is a big part of what led to its ultimate downfall.

"They were subsidizing it and taking losses to get clients in the door," said Castle Island Venture's Nic Carter. "The yields on the other end were fake and subsidized. Basically, they were pulling through returns from [Ponzi schemes]."

Three weeks after Celsius halted all withdrawals due to "extreme market conditions" — and a few days before the crypto lender ultimately filed for bankruptcy protection — the platform was still advertising in big bold text on its website annual returns of nearly 19%, which paid out weekly.

"Transfer your crypto to Celsius and you could be earning up to 18.63% APY in minutes," read the website on July 3.

Promises such as these helped to rapidly lure in new users. Celsius said it had 1.7 million customers, as of June.

The company's bankruptcy filing shows that Celsius also has more than 100,000 creditors, some of whom lent the platform cash without any collateral to back up the arrangement. The list of its top 50 unsecured creditors, includes Sam Bankman-Fried's trading firm Alameda Research, as well as an investment firm based in the Cayman Islands.

Those creditors are likely first in line to get their money back, should there be anything for the taking — with mom and pop investors left holding the bag.

After filing its bankruptcy petition, Celsius clarified that "most account activity will be paused until further notice" and that it was "not requesting authority to allow customer withdrawals at this time."

The FAQ goes on to say that reward accruals are also halted through the Chapter 11 bankruptcy process, and customers will not be receiving reward distributions at this time.

That means customers trying to access their crypto cash are out of luck for now. It is also unclear whether bankruptcy proceedings will ultimately enable customers to ever recoup their losses. If there is some sort of payout at the end of what could be a multi-year process, there is also the question of who would be first in line to get it.

Unlike the traditional banking system, which typically insures customer deposits, there aren't formal consumer protections in place to safeguard user funds when things go wrong. 

Celsius spells out in its terms and conditions that any digital asset transferred to the platform constitutes a loan from the user to Celsius. Because there was no collateral put up by Celsius, customer funds were essentially just unsecured loans to the platform.

Also in the fine print of Celsius' terms and conditions is a warning that in the event of bankruptcy, "any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable" and that customers "may not have any legal remedies or rights in connection with Celsius' obligations." The disclosure reads like an attempt at blanket immunity from legal wrongdoing, should things ever go south.

Another popular lending platform catering to retail investors with high-yield offerings is Voyager Digital, which has 3.5 million customers and recently filed for bankruptcy, as well.

To reassure their millions of users, Voyager CEO Stephen Ehrlich tweeted that after the company goes through bankruptcy proceedings, users with crypto in their account would potentially be eligible for a sort of grab bag of stuff, including a combination of the crypto in their account, common shares in the reorganized Voyager, Voyager tokens, and then whatever proceeds they are able to get from the company's now-defunct loan to the once prominent crypto hedge fund Three Arrows Capital.

It is unclear what the Voyager token would actually be worth, or whether any of this will come together in the end.

Three Arrows Capital is the third major crypto player seeking bankruptcy protection in a U.S. federal courtroom, in a trend that can't help beg the question: Will bankruptcy court ultimately be the place where new precedent in the crypto sector is set, in a sort of regulate-by-ruling model?

Lawmakers on Capitol Hill are already looking to establish more ground rules.

Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., are aiming to provide clarity with a bill that lays out a comprehensive framework for regulating the crypto industry and divvies up oversight among regulators like the Securities and Exchange Commission and the Commodity Futures Trading Commission.

Celsius' overarching problem is that the nearly 20% APY it was offering to customers wasn't real.

In one lawsuit, Celsius is being accused of operating a Ponzi scheme, in which it paid early depositors with the money it got from new users.

Celsius also invested its funds in other platforms offering similarly sky-high returns, in order to keep its business model afloat.

A report from The Block found that Celsius had at least half a billion dollars invested in Anchor, which was the flagship lending platform of the now failed U.S. dollar-pegged stablecoin project terraUSD (UST). Anchor promised investors a 20% annual percentage yield on their UST holdings — a rate many analysts said was unsustainable.

Celsius was one of multiple platforms to park its cash with Anchor, which is a big part of why the cascade of major failures was so significant and swift after the UST project imploded in May.

"They always have to source yield, so they move the assets around into risky instruments that are impossible to hedge," said Nik Bhatia, founder of The Bitcoin Layer and adjunct professor of finance at the University of Southern California.

As for the $1.2 billion gap in its balance sheet, Bhatia chalks it up to poor risk models and the fact that collateral was sold out from under it by institutional lenders.

"They probably lost customer deposits in UST," Bhatia added. "When the assets go down in price, that's how you get a 'hole.' The liability remains, so again, poor risk models."

Celsius isn't alone. Cracks keep forming in the lending corner of the crypto market. Castle Island Venture's Carter says the net effect of all this is that credit is being destroyed and withdrawn, underwriting standards are being tightened, and solvency is being tested, so everyone is withdrawing liquidity from crypto lenders.

"This has the effect of driving up yields, as credit gets more scarce," said Carter, who noted that we're already seeing this happen.

Carter expects to see a general inflationary deleveraging in the U.S. and elsewhere, which he says only further makes the case for stablecoins, as relatively hard money, and bitcoin, as truly hard money.

"But the portion of the industry that relies on the issuance of frivolous tokens will be forced to change," he said. "So I expect the result to be heterogeneous across the crypto space, depending on the specific sector."