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If crypto lending platform Celsius goes bankrupt, users might not be able to get their money back

June 14, 2022, 7:27 AM UTC

Celsius Network’s users are coming to an uncomfortable realization after the DeFi platform froze withdrawals on Sunday: If the crypto lender goes under, users may never be able to get their funds back.

Celsius has styled itself as an alternative to the traditional banking world, with both the network and CEO Alex Mashinsky often arguing that “banks are not your friend.” And Celsius is indeed different from banks in one key way. Unlike banks, Celsius doesn’t offer its depositors any guarantee that their money is safe in the event the platform becomes insolvent.

Celsius is not a bank

In its terms of use, Celsius notes that users depositing money in an interest-paying “Earn” account grant the company “all right and title to such Eligible Digital Assets, including ownership rights.” Celsius spells out what that means, namely that users “will not be able to exercise rights of ownership,” have no claim to any compensation Celsius gets for lending out those assets, and that if Celsius goes bankrupt, “you may not be able to recover or regain ownership of such Digital Assets.”

Celsius then warns users that “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’s “Custody” accounts, which merely hold cryptocurrency and do not pay interest, don’t require users to grant title to Celsius, but even with these accounts Celsius admits that an insolvency proceeding could “result in a number of outcomes that are impossible to predict reliably, including but not limited to you being treated as an unsecured creditor and/or the total loss of any and all Digital Assets reflected in your Celsius Account.”

Unsecured creditors often have to go to the back of the queue in bankruptcy proceedings, meaning if Celsius did declare bankruptcy, crypto funds from “unsecured creditors” could be used to pay off other creditors first.

Celsius did not immediately respond to a request for comment. 

Celsius offers high interest rates—sometimes as high as 30% APY, paid weekly—to encourage users to deposit cryptocurrency on its platform. The network then uses that liquidity to lend cryptocurrency to other users, but the recent crypto crash unleashed a liquidity crisis on the company.

According to the Financial Times, the value of assets stored on Celsius had fallen by 50% between November and May. To avoid greater losses, some Celsius users began moving funds off the platform, leading to complaints that some users were having difficulty withdrawing their funds. The crypto crash is also sinking the value of Celsius’s holdings, like its large pool of “Lido Staked Ether,” a token that—until recently—was pegged 1:1 to Ether.

That means Celsius is getting hit with a double whammy of sinking asset values and increased investor skittishness, potentially sparking a liquidity crisis and a looming insolvency.

Last Wednesday, Celsius said that it had no issues with withdrawals, and that it “has the reserves (and more than enough ETH) to meet obligations.” On Sunday, Celsius said it was freezing withdrawals to “stabilize liquidity.”

Depositor protection

Depositors at retail banks are often protected by deposit insurance. Customers at U.S. banks, for instance, are protected by the Federal Deposit Insurance Corporation, a U.S. government corporation. When a bank fails, the FDIC steps in to protect customer savings, up to a level of $250,000. The FDIC is credited with restoring trust in the banking system after the Great Depression caused many banks to fail.

Celsius users don’t have that same protection, a point the network makes in all caps as part of its terms of use. Users might have found that lack of protection acceptable before Celsius put a freeze on withdrawals. Now, users might be having second thoughts.

“The second they turn on user withdrawals again, every single user is going to withdraw every single penny,” Columbia Business School professor Omid Malekan told Fortune

Celsius is not the only entity in the cryptocurrency space to warn users that they might lose their assets in a bankruptcy event.

In May, Coinbase added similar language in its earnings report. The cryptocurrency exchange noted that the cryptocurrency it holds on behalf of its users could be subject to proceedings in a bankruptcy event, meaning a customer’s digital assets might end up being used to pay other creditors first.

At the time, Coinbase CEO Brian Armstrong said the disclosure was made owing to new rules from the U.S. Securities and Exchange Commission regarding public companies with interests in cryptocurrencies. 

Celsius’s decision to halt services extended a plunge in crypto markets on Monday. Bitcoin fell about 15.7% since Celsius’s announcement that it was freezing withdrawals on Sunday evening, to reach $21,694 as of 11:30 a.m. Hong Kong time.

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