CELSIUS: ANOTHER CHAPTER OF STRESS IN THE HISTORY OF THE CRYPTO MARKET

Although the crypto asset market is still a new industry, elements such as leverage and other strategies for obtaining returns on capital, transposed from the traditional financial market, already occupy their space in this new financial ecosystem.

With the rapid growth of the market, soon the need to resort to increasingly exotic, sophisticated and risky instruments of profitability emerged, with the search for the maturation of existing strategies.

Such strategies, added to the troubled context that has been faced by the market - a context that started on May 3 with the collapse of TerraLuna and that extends until the date of production of this report - may come to extend the fall, which already positions the marketcap of the crypto market by less than $1 trillion.

To understand these developments, let's address the case of Celsius Network, a protocol that presents a very high risk of liquidity crisis and that has already shown some signs of this during the past week, as a result of failed leverage strategies.

Conceived in 2017, Celsius Network is a provider of easy access to crypto lending services, enabling users to borrow and lend at attractive interest rates.

As a custodian of assets, the protocol reinforces in its business proposal and white paper the priority regarding the supposed non-exposure of its users to the inconveniences and risks of the crypto market.

The Celsius wallet is designed in a way that allows users to use cryptocurrencies as collateral to obtain a dollar loan and has been named the best cryptocurrency wallet in 2021, offering the highest interest rate compared to competitors.

Using the platform, the user can borrow various cryptocurrencies (+40 accepted), depositing their assets to be borrowed in exchange for interest or serve as collateral, as it is also possible to borrow in cash (USD$) or CEL (native Celsius token).

By putting money into the protocol, users are able to earn weekly returns that, according to Celsius' website, are in excess of 8% APR.

The protocol utilizes the assets in custody to grant borrower loans at higher rates within the protocol and mining of BTC.

The distrust regarding the performance strategies presented - very different from those observed in financial institutions - also generates distrust of other similar platforms in the sector, such as BlockFi. This has helped fuel the FUD scenario that has been on the market over the last month, with the meltdown of Terra Luna USDT, and has put Celsius Network and its token at the center of the market scrutiny arena in recent weeks, with the existence of a liquidity risk of this major player hitting the market hard.

Last Sunday (12), Celsius lit the red light for the market when it publicly announced the interruption of all services for withdrawals, transfers and exchanges of assets within the platform, according to a statement posted on the institutional blog:

However, although the focus with the action of freezing operations was singular, the reasons for the problem were multiple.

The promise of high returns combined with the protocol's image of credential legitimacy opened the way for unsustainable trading strategies by the platform: 1) use of leverage and 2) the adoption of stETH, being the main ones.

Let's analyze them individually.

In order to provide loans at such low rates and above-average profitability to users, Celsius' leverage is on two fronts. The first is permissionless on-chain marketplaces such as MakerDAO.

Maker is a collateralized lending protocol, with ETH or WBTC deposit as collateral for the loan of, for example, the stablecoin DAI.

When the collateral value falls below a pre-established liquidation threshold, the collateral position is liquidated to repay the loan and avoid bad debts. Leverage on DeFi protocols would not be that problematic in itself, as the drop in value of Celsius collateral on other platforms implies drop in value of loan collateral for Celsius's own customers.

However, with the possession of 17,919 WBTC leveraged on the Maker protocol and occupying the position of highest individual debt in the protocol with US$ 278 thousand in DAI, Celsius Network began to face leverage problems with the fall in the price of BTC and the consequent fall. value of other tokens, such as ETH, increasing the chances of collateral settlement.

The solution found by Celsius was to complement its loan vault with additional guarantees, paying part of the debt, in order to ensure that the settlement price of its funds was high, thus avoiding the execution of the settlement.

Approximately US$37 million in debt was paid, raising the settlement price to US$22,000.

With the temporary resolution of the secured loan vault situation at Maker, attention has turned to Celsius' use of stETH, which comes into play as the second pillar of Celsius' failed income-generating strategy.

In addition to depositing user funds in protocols such as Anchor to earn income, Celsius also held a large share of funds in stETH - a liquid derivative of LidoFinance, which allows the staking of ETH tokens for access to liquid capital in the form of the stETH token. , which can be staked on various DeFi protocols to receive income (APY) or serve as collateral for loans.

The big problem is that the staking made in ETH is locked in the Beacon Chain of the Ethereum network until The Merge, which is the merger between the chains and the transition to the Proof-of-Stake model, and only then the release occurs. redemption of ETH tokens.

In other words, the rescue mechanism is a one-way street. This means that once ETH is staked, it is not possible to undo the funds position until the merger to PoS is successful, an event expected by the end of 2022.

Thus, the position of 409,260 stETH, equivalent to US$ 475 million, held by Celsius, can only be effectively undone in the event of The Merge of Ethereum.

By now you must be asking yourself: “what's so big if Celsius is getting APY over the position in stETH?”.

Well, the problem with the position is that Celsius was promoting a very high yield rate for its users' ETH tokens within the platform, these tokens staked on LidoFinance to receive stETH, which was later promised as a guarantee to receive more yield. in different DeFi protocols.

In other words, the adoption of stETH by Celsius was nothing more than another aspect of leverage, and with an additional risk, the loss of parity of stETH with the price of ETH, which occurred during the month.

All this fueled rumors of Celsius' potential functional illiquidity, scaring the market.

The USD quote of both tokens (ETH and stETH) on June 15, when the parity loss occurred.

Curve pooled stETH and ETH balance

The loss of the peg directly affected the liquidity of the market to buy ETH through stETH, leading users to withdraw their funds from the Celsius platform in fear of using their assets to rebalance the platform's liquidity.

The mass movement of capital withdrawal from Celsius’ reserves resulted in the CEL token (the platform’s native token) falling in value, demonstrating the pricing of fear of the Celsius protocol liquidity crisis by the market.

The liquidity rush of Celsius users was expressed by the graphical view of the CEL token with a 92% drop since the High High Reached.

There are several reasons why stETH may be traded, even temporarily, unpaired from its collateral value. Variations in liquidity premiums (as an incentive or disincentive), risk discount rates for operational bugs, or even an increase in the presence of forced sellers using leverage, for example.

In the current context, this last factor is what is fueling the FUD around stETH, which, being traded at a high discount rate, has placed Celsius with its large investment in the token in the delicate context of an impending liquidity crisis.

The 409,260 position in stETH ($475 million at the time of writing) has been allocated completely as collateral in the Aave protocol vault. And, although Celsius itself claims to have the situation under control, it is a fact that the amount of stETH held used as collateral for loaning in stablecoins poses a significant liquidity risk to the protocol, especially due to the problematic and investor aversion context involving stablecoins that drew in the last month.

Total loan amount from Celsius at Aave; including assets in Compound, the company pledged $1 billion in collateral to borrow $500 million worth of stablecoins, with stETH being the bulk of that collateral.

It is worth mentioning that all this turmoil that Celsius is going through today is intensified by the macro context of the crypto market, not being entirely an internal event of the Celsius Network.

All of this is also taking place while other major players such as Three Arrows Capital (3AC) are pouring stETH positions into the market for what appears to be a liquidity preference. 3AC, for example, liquidated around US$40M stETH in the last week, totaling US$400M in already liquidated token positions, and still has the risk of holding an additional US$300M in liquidations in the event of an extension of the movement. of the crypto market, which has accentuated in the last 10 days.

The movement of liquidations and mass sell-off that the market comes facing, a movement that started in May with the collapse of the TerraLuna token (UST), still has room to expand. These events leave a valuable market lesson, which concerns leverage. Abuse of leveraged positions hardly ends well, even more so if user funds are used to fuel these positions.

A possible further liquidation of Celsius, the result of a kind of bank run on the platform, and a deterioration of the situation and liquidity of other leveraged players could trigger an even sharper devaluation of the crypto market.

Some lessons are learned from the recent episodes that the crypto market has been going through. The first is the need to be suspicious of feedback systems that promise high gains and depend on the entry of new participants to generate liquidity and acquire a token that may not really make sense.

The business strategy used by Celsius positioned it as a non-failure, safe system focused on user convenience, promoting extremely attractive conditions and ease of moving resources.

However, the constant need for the entry of more and more users and capital to feed the platform's internal pools with the CEL token is one of the self-reinforcing triggers that guarantees the system to continue working; with the cessation of this movement, and until its reversal with the withdrawal of capital from the platform, the whole system collapses.

Something similar was seen with TerraLuna, which constantly stressed the need to actively generate sufficient demand to ensure the survival of the UST.

The second and final point that we want to raise is not exactly a lesson learned, but more a questioning reinforced. “Not your keys not your coins”. The use of custody protocols (whether online wallets or staking loan protocols) is common, due to the convenience and confidence generated in their security. But convenience comes at a high cost when funds are lost or you have to watch them melt away in value without being able to withdraw them from a pool.

It is important to emphasize that the risk of loss always exists, but with self-custody, the risk, responsibility, effort or merit is yours. The timing of action and decisions are yours and not that of a custodian that, no matter how consolidated and well-intentioned it may be, prioritizes something other than YOUR capital in full in the long term.

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