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As Celsius freezes assets, a big Canadian pension plan that backed the network is on the hook

June 14, 2022, 12:55 PM UTC

Let’s talk about insolvency.

If you follow the crypto markets, that’s what’s top of mind right now when it comes to the Celsius Network, the crypto lending platform that said it had nearly $12 billion in AUM in mid-May. The startup, which was valued at more than $4 billion in November, is backed by WestCap, and it was one of the first blockchain investments for Canada’s second largest pension fund, CDPQ. The Network’s Bitcoin mining subsidiary confidentially filed for an IPO earlier this year. 

Late Sunday, amid crypto’s steep market declines, the Network said that its users would no longer be able to withdraw, transfer, or swap their assets—at least for now. Mere weeks after the downfall of stablecoin TerraUSD, questions are swirling around the billions in assets Celsius Network says it manages, and how much of those funds will ultimately be available to investors who are hoping to see that money again.

Here’s the thing: Billions of those assets could be tied up in investments elsewhere for now, but—in time—be made available to investors who want to withdraw their deposits. The alternative is that Celsius Network can’t make good on its investors’ crypto, which would be much, much worse. Two days after the Celsius Network restricted its investors from moving assets on its platform, it’s unclear which scenario the company currently finds itself in. (A company spokesperson didn’t respond to a request for comment)

That second scenario—while certainly awful for investors who may lose their capital—could also prove rather unfortunate for Celsius Network’s two largest investors, CDPQ and WestCap, who led a nearly $900 million Series B round for the company in November that valued it at more than $4 billion. CDPQ’s stake may only be a fraction of the $40 billion it said it had invested in financial services, but it’s still nothing to sneeze at.

“Celsius is taking proactive action to uphold its obligations to its customers (Celsius community) and has honoured its obligation to its customers to date. Our team is closely monitoring the situation,” a CDPQ spokesperson said in an emailed statement, noting that generalized market declines have caused investors to reduce their risk in all asset classes. A WestCap spokesperson didn’t respond to a request for comment.

There’s been alarm raging within the crypto markets for weeks—particularly after stablecoin TerraUSD lost its peg, and investors wonder which companies and funds were exposed, and by how much. 

To make matters worse, there’s some reason to doubt some of the assurances Celsius Network CEO Alex Mashinsky, who Bloomberg described in January as a “charismatic pitchman who feeds off his customers’ energy,” has offered in recent weeks. Mashinsky said just recently that Celsius has “billions of dollars in liquidity,” and that anyone who wanted to withdraw could, though the company shortly after put restrictions in place.

The Network is one of the largest crypto lending platforms in the industry (others being BlockFi or Genesis Capital). We already know that crypto lending introduces some level of risk into the system. From recent research published in the Financial Stability Review, in reference to crypto leverage and lending: “We conclude that if the present trajectory of growth in the size and complexity of the crypto-asset ecosystem continues, and if financial institutions become increasingly involved with crypto-assets, then crypto-assets will pose a risk to financial stability.” And the Securities and Exchange Commission is paying attention. It started investigating several companies that offer interest on crypto last year, and it ended up fining BlockFi $100 million for selling unregistered securities a few months back. Some state regulators have taken issue with Celsius in particular.

But the key question at hand now is where exactly investor money is tied up. Like a bank, DeFi apps lend out or invest crypto in order to secure high interest rates (the Celsius Network offered up to 18%) and earn revenue. The thing about depositing money with a bank is that you get FDIC insurance—meaning that, should your bank default, you’ll get up to $250,000 back. 

DeFi applications may operate like banks, but you could also lose everything, and there’s no regulator overseeing how deposits and collateral are handled.

Former employees told Bloomberg earlier this year that some investors might be surprised with risks Celsius has taken with their money. And the Celsius Network’s own terms of use indicates that the startup might practice rehypothecation, which means that a startup could use collateral an investor already used to get a loan in order to secure its own loan.

Per the aformentioned Financial Stability Review, rehypothecation could “cause liquidity to vanish very quickly in the case of a big shock.” High volatility of crypto assets could require more collateral from borrowers—who could then lose that collateral. 

It’s not apparent that rehypothecation was happening at the Celsius Network, but disclosures indicate that it could have been—and it’s been raised as a potential issue for two years. Here’s the exact language from Celsius Network’s disclosures: “You grant Celsius… All right and title to such Eligible Digital Assets, including ownership rights, and the right, without further notice to you, to hold such Digital Assets in Celsius’ own Virtual Wallet or elsewhere, and to pledge, re-pledge, hypothecate, rehypothecate, sell, lend, or otherwise transfer or use any amount of such Digital Assets… And to use or invest such Digital Assets in Celsius’ full discretion.” 

What’s at risk, you ask? Well, everything: “In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations, any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws.”

Celsius’ website boasts of “military-grade security” and “next-level transparency” but right now it’s not clear if customers are getting either. 

More bad news in crypto… In an SEC filing from this morning, crypto exchange Coinbase said it was restructuring and laying off approximately 18% of its staff, or some 1,100 people. This comes a day after BlockFi said it was cutting 20% of employees.

See you tomorrow,

Jessica Mathews
Twitter: @jessicakmathews
Email: jessica.mathews@fortune.com
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