Crypto Crash Pauses, Celsius Still Frozen

Coin prices have stabilised but platforms are facing serious questions about how investor money is used, and how they can access it when the market turns

James Gard 14 June, 2022 | 8:14AM
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The panic that gripped the cryptocurrency market on Monday appeared to have subsided on Tuesday morning, with coin prices pausing their dramatic declines. But serious concerns remain over one of the triggers of yesterday’s crash, the Celsius Network platform, where withdrawals still remain suspended.

At 10am BST, Bitcoin was up 0.45% to US$22,563. Ethereum was up less than 1% at US$1,219, and Tether, which is pegged to the U.S. dollar, was flat at US$1. Most coins are nursing heavy losses this year amid a series of problems that have upset the bull market narrative. Terra’s implosion in May was the trigger for recent volatility, and now Celsius’s problems have followed swiftly, spurring another down leg for the major coins.

On Monday the platform said it was suspending withdrawals, swap and transfers between accounts, blaming "extreme market conditions".

On the same day, U.S. platform Binance, a rival to listed peer Coinbase (COIN), also announced technical problems were forcing it to suspend withdrawals. For those of a conspiratorial mindset, it looked like platforms were shutting the doors to stop an exodus.

Online Skeptics Think Something's Fishy

As usual, the online debate is highly polarised: crypto sceptics think this is the moment the bubble bursts and are relishing the daily lurches downwards, while true believers are (less convincingly) exhorting other zealots to keep the faith, ride this wobble out and even add to their holdings.

One Twitter commentator, "@concodanomics" tweeted, provocatively, "Celsius is Bear Stearns, Tether is Lehman Brothers" (Bear Stearns’ collapse preceded that of Lehman Brothers in the 2008-2009 financial crisis, and the latter was the “big one” that tested the global financial system).

While Bitcoin was supposed to remodel finance, the investor psychology here is as old as time: late adopters' rush for the exit (a digital bank run), the disbelief of the heavily invested, and the optimism of the opportunist "dip buyers" are all at play.

Binance has since confirmed people can withdraw from its platform, calming some nerves on Tuesday. Unfounded rumours swirled on Monday that Coinbase had also suspended withdrawals and the share price shed 11% on Monday to close at $52 – a sign of the crossover between the new crypto frontier and listed securities.

Coinbase to Axe 18% of Employees

In what seems like an eternity ago in terms of sentiment, Coinbase shares opened at US$381 in April 2021, and hit nearly US$430 in early trading. Morningstar assigns Coinbase shares a fair value of US$131, implying a substantial uplift from current levels, but its Uncertainty Rating is "very high". And for good reason. 

On Tuesday afternoon, Coinbase chief executive Brian Armstrong announced the company was reducing its staff headcount by 18%, citing the likelihood of a recession and resulting "crypto winter".

"We appear to be entering a recession after a 10+ year economic boom. A recession could lead to another crypto winter, and could last for an extended period," he told employees in a memo.

"As we operate in this highly uncertain period [...] we want to ensure we can successfully navigate a prolonged downturn. Our team has grown very quickly (>4x in the past 18 months) and our employee costs are too high to effectively manage this uncertain market. The actions we are taking today will allow us to more confidently manage through this period even if it is severely prolonged." Affected staff were immediately frozen out of the company's internal systems. 

Why The Celsius Saga Matters

What’s going on at U.S.-Israeli firm Celsius and why does it matter for the crypto debate?

Celsius is a decentralised finance (DeFi) platform where people can buy and sell coins, as with Coinbase, but it also has its own “native token”, CEL, which also plunged in yesterday’s turmoil. Unlike, say, a traditional stock exchange or investment platform, users of Celsius can borrow and lend money to others in the network – lenders get paid for this in the form of interest rates up to 7% and borrowers get to be part of the crypto rollercoaster and leverage up their returns.

This business model makes regulators nervous: Celsius ceased operations in the UK citing regulatory uncertainty, while four U.S. states have effectively banned the network. The Securities and Exchange Commission is looking closely at platforms that offer lending, forcing strategic U-turns from big names like Coinbase, which had planned a similar product.

Celsius also offers sign-up deals worth US$2,000 of free Bitcoin, promising “military-grade security”, “next-level transparency” and the ability to “access your coins whenever, keep the same forever”, with loans starting at 1% and rates up to 17% for lenders.

With interest rates at record lows, an interest rate of up to 17% may have been too tempting for some – although sensible people may have raised some concerns about how this high yield is achieved.

What’s concerning investors now is who owns what – if you put money in a platform, is it theirs or yours? Coinbase recently said that in the event of bankruptcy, customers may lose their coins – which was received as heresy among crypto purists.

A similar issue is at stake with Celsius. Banking expert Francis Coppola has tweeted that investors make the mistake of thinking that platforms are custodians of your money in the same way that Vanguard, BlackRock are in the world of regulated mainstream finance.

"It's an unregulated bank. Celsius says in its T&Cs that coins you deposit with it or pledge to it become its property to do with as it pleases. That's a banking model, not an asset management model,” she tweeted. "Deposits are backed solely by an opaque pile of risky loans."

Ben Hunt (@EpsilonTheory) says the Celsius debacle raises (again) the issue of "rehypothecation":

"Every generation of investors discovers counterparty risk the hard way. Today would be a good day to read the fine print on your margin account at COIN or HOOD. Also, if you don’t know what ‘rehypothecation’ means, it would behove you to learn."

Who Owns What?

As the International Monetary Fund explained in its paper on shadow banking, rehypothecation is "the practice that allows collateral posted by, say, a hedge fund to its prime broker to be used again as collateral by that prime broker for its own funding."

In simple terms, firms can use client money to cover their loan obligations. This isn’t new in the world of securities broking and is certainly not illegal, but it fell out of favour after the financial crisis, when investors started taking a great interest in how and where their money was put to use.

In finance, most customers expect their money to be held in separate accounts, and it’s a regulatory requirement in many case.

In the crypto gold rush, where prices were soaring, investors probably didn’t ask the questions that lie at the heart of the contract between individual and institution: how are you looking after my money and if things go wrong, can I get it back?

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James Gard

James Gard  James Gard is senior editor for Morningstar.co.uk.

 

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