The Revenue Model of CeFi Platforms

Celsius operates on a straightforward business model. It collects user deposits in cash or cryptocurrencies and then lends these assets at a higher interest rate to institutional clients or large investors who engage in margin trading and other activities. The difference between what borrowers pay and what depositors earn constitutes the company's profit margin.

With interest rates reaching as high as 18.63% and the appeal of weekly payouts, Celsius successfully attracted approximately 1.7 million customers. Their marketing emphasized earning returns without risk, which seemed to address one of the primary obstacles in crypto investing. However, the recent turmoil has illustrated that no platform is immune to market volatility.

To comprehend the Celsius debacle, we should revisit another major market event that sent shockwaves through the industry.

The Terra Luna Disaster

The collapse of Luna’s Terra USD stablecoin triggered widespread panic in the crypto market, marking one of the most significant wealth-destroying events in its history. Celsius played a role in this catastrophe by offering a 20% return on USD-pegged stablecoins, including TerraUSD, making it a highly sought-after product.

When the crypto market faltered, the mechanism designed to maintain the stablecoin's $1 peg broke, leading to a staggering 97% price drop within 48 hours. As investors faced immense losses, the $40 billion protocol fell alongside it.

Media outlets and analysts claimed that major institutions suffered due to over-leveraging. However, the situation was more complex, highlighting that the failures of these centralized finance platforms were not merely a result of investor greed.

The High-Stakes Risk of Celsius’s Business Model

While some believe centralized platforms are too big to fail, recent events show that they can be just as susceptible to market fluctuations as any other entity. The crux of the issue lies in their business models, which rely on taking substantial risks. When market conditions shift unfavorably, these companies have limited options for protection.

Celsius's centralized structure has left customers vulnerable, with little recourse when issues arise. This was starkly illustrated when the value of TerraUSD collapsed, revealing Celsius's inability to honor its high yield commitments. At that moment, the platform held nearly $500 million in the stablecoin, but it was the customers who bore the brunt of the fallout.

The Crisis Driven by Staked $ETH

Celsius advertised interest rates of 6–8% on ETH deposits, primarily funded by staking rewards from Ethereum’s Proof-of-Stake Beacon chain. However, the challenge with this approach is that the staked assets are locked, preventing investors from unstaking their holdings.

Lido facilitates access to the derivatives market by creating a derivative asset called Lido Staked ETH or $stETH. Although $stETH has typically traded at a 1-to-1 ratio, it is not pegged and can fluctuate. Celsius relied heavily on this ratio remaining stable to meet its obligations, which worked during bullish market conditions but faltered in the current bear market, leading to liquidity issues.

Celsius's Mismatched Liabilities

It has become evident that Celsius did not adequately isolate risk. The platform is now facing a liquidity crisis, struggling to balance liabilities (deposits) with assets (on-chain holdings). Some customer deposits were tied up in USDC and Ethereum with $stETH.

As the crypto market crumbled and customers clamored for their funds, Celsius found itself in a precarious situation. To safeguard its financial standing, the platform halted withdrawals, claiming this action was a temporary measure to address the crisis.

This situation reveals a stark mismatch: Celsius needs to locate $8.5 billion to meet customer obligations, yet it possesses only $1.5 billion. With crypto prices continuing to decline, the original $1.5 billion in on-chain assets is rapidly diminishing. A significant portion of customers' deposits remains illiquid.

The remaining funds are trapped in various locations:

• $400 million staked on Ethereum's Beacon chain
• $400 million leveraged in the Maker protocol, nearing liquidation
• Prior to the collapse of TerraUSD, Celsius had allocated $275 million worth of $ETH to the Anchor protocol

This vulnerability is further exacerbated by institutional trading firms that often seek out these fragile positions. When forced liquidations occur, they tend to drive prices down aggressively to profit.

At this point, the whereabouts of the remaining funds remain uncertain. They could be lent out or held on centralized exchanges. Regardless, one fact remains clear: Celsius's customers are desperate to recover their assets.

Will Celsius Overcome Its Self-Inflicted Crisis?

There is a possibility that Celsius remains solvent but is facing liquidity challenges. If they are not insolvent, they could negotiate with larger investors to offload illiquid positions at discounted rates. However, if their assets and liabilities fail to align, the platform's future is bleak.

Celsius will require assistance, whether through external funding, substantial loans, or an acquisition. Nexo, another well-known CeFi platform, has expressed interest in acquiring Celsius. However, such a move could endanger Nexo’s existing clientele.

The direst outcome would be if Celsius collapses entirely, necessitating bankruptcy proceedings to salvage the company. In that scenario, customers who entrusted their funds to the platform would face devastating losses.

These unsettling events surrounding Celsius and similar staking protocols underscore a crucial lesson: the cryptocurrency sector demands regulatory oversight. Stricter regulations are essential to safeguard consumers and investors from incurring further financial losses in the future.

Ultimately, it’s vital to remember the original purpose of blockchain technology: to address the double-spend issue and introduce a truly peer-to-peer cashless system, as exemplified by Bitcoin. Since Bitcoin's inception, the focus has shifted toward greed, speculation, and manipulation, overshadowing its foundational goal of facilitating P2P transactions.

This article was first published in the Money vs. Machine newsletter. Subscribe to stay updated on our latest stories.

The first video titled "Reckless Greed | The Celsius Bankruptcy Explained" delves into the factors leading to Celsius's downfall, providing insights into the broader implications for the cryptocurrency landscape.

The second video, "Customers Lose Billions? - Explaining Crypto Lending Meltdown," examines the financial fallout from Celsius's struggles and the effects on its user base.