Case 2 – Crypto Winter Buries Celsius Network and Batters DeFi

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UV8663 Feb. 14, 2023

Crypto Winter Buries Celsius Network and Batters DeFi

Celsius is going after all the money in the world.

—Alex Mashinsky, Celsius Network Ltd. Founder and CEO1

In June 2022, major cryptocurrency (crypto) lender Celsius Network Ltd. (Celsius) froze the accounts of its 1.7 million clients, sending shockwaves across the burgeoning and largely unregulated decentralized finance (DeFi) industry. Cryptos were in a free fall, and Celsius’s clients had made withdrawals at a rate that mirrored a bank run. The consequences were disastrous; on July 14, Celsius filed for Chapter 11 bankruptcy protection. Assets under management (AUM) were under $200 million, an unimaginable drop from October 2021 when the firm’s AUM were $25 billion.2 At the time of the bankruptcy filing, Celsius owed its clients nearly $5 billion.3

Decentralized Finance

DeFi was a new and disruptive vision of banking and financial products and services—such as payments, lending, borrowing, trading and investments, capital raising, and insurance—conducted without a trusted central authority (e.g., bank, brokers, and stock exchanges).4 Instead, DeFi relied primarily on Ethereum blockchain technology (ledgers connected by a network of computers) to record and share data. It used smart contracts—self-executing software—to record transactions and transfer funds. Smart contracts were used to create decentralized applications (dApps) that provided financial products and services. Smart contracts were “if-then” statements between two parties and were not without their risks. “Smart contracts introduce an additional risk that does not exist in most text-based contractual relationships—the possibility that the contract will be hacked or that the code or protocol simply contains an unintended programming error,” wrote lawyers. “Given the relative security of blockchains, these concepts are closely aligned; namely, most ‘hacks’ associated with blockchain technology are really exploitations of an unintended coding error.”5

Alex Moskov, “Crypto Interest Account Pioneer Alex Mashinsky and Takes on Big Finance,” Coin Central, May 25, 2020, https://coincentral.com/crypto-interest-account-pioneer-alex-mashinsky-and-takes-on-big-finance/ (accessed Sept. 14, 2022).

2 MacKenzie Sigalos, “ From $25 Billion to $167 Million: How a Major Crypto Lender Collapsed and Dragged Many Investors Down with It,” CNBC, July 18, 2022, https://www.cnbc.com/2022/07/17/how-the-fall-of-celsius-dragged-down-crypto-investors.html (accessed Sept. 13, 2022).

3 https://www.cnbc.com/2022/07/17/how-the-fall-of-celsius-dragged-down-crypto-investors.html. 4 Francesca Carapella et al., “Decentralized Finance (DeFi): Transformative Potential and Associated Risks,” Finance and Economics Discussion

Series 2022-057 (Washington, DC: Board of Governors of the Federal Reserve System, 2022). 5 Stuart D. Levi and Alex P. Lipton, “An Introduction to Smart Contracts and Their Potential and Inherent Limitations,” Harvard Law School Forum

on Corporate Governance, May 26, 2018, https://corpgov.law.harvard.edu/2018/05/26/an-introduction-to-smart-contracts-and-their-potential-and- inherent-limitations/ (accessed Nov. 1, 2022).

This public-sourced case was prepared by George (Yiorgos) Allayannis, Robert F. Bruner Distinguished Professor of Business Administration, and Aldo Sesia, Senior Case Researcher. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2023 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an email to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to [email protected].

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Governance tokens were used to establish decentralized governance on a blockchain project. They gave holders a vote in how the project was run. Projects used various calculation methods to award their governance tokens to their stakeholders (e.g., founders, investors, and users). Generally, smart contracts tabulated the votes of token holders.

Advocates of DeFi believed it would solve problems with traditional centralized finance including inefficiency, limited access, and opacity, among others. Scholars wrote,

A centralized financial system has many inefficiencies. Perhaps the most egregious example is the credit card interchange rate that causes consumers and small businesses to lose up to 3% of a transaction’s value with every swipe due to the payment network oligopoly’s pricing power…Today, 1.7 billion people are unbanked making it very challenging for them to obtain loans and to operate in the world of internet commerce. Further, many consumers must resort to pay-day lending operations to cover liquidity shortfalls. Being banked, however, does not guarantee access…The current financial system is not transparent. Bank customers have very little information on the financial health of their bank and must place their faith in the limited government protection of FDIC [Federal Deposit Insurance Corporation] insurance on their deposits…Centralization has many layers. Most consumers and businesses deal with a single, localized bank. The bank controls rates and fees. Switching is possible, but it can be costly. Further, the US banking system is highly concentrated…Our financial system is siloed and designed to sustain high switching costs. Moving money from one institution to another can be unduly lengthy and complicated.6

Still, they cautioned, “Blockchains can remove traditional financial risks, such as counterparty risk, with their unique properties, but DeFi is built on code. This software foundation gives attackers a larger attack surface than the threat vectors of traditional financial institutions.”7

DeFi projects was the term used to describe offerings. Common DeFi projects included decentralized exchanges (DEXs), lending and borrowing, derivatives, payments, insurance, savings, wallets, and stablecoins. (See Exhibit 1 for total value locked for DeFi from November 2018 to June 2022 for multiple blockchains.)

Stablecoins

Crypto (or digital money) was the lifeblood of DeFi, particularly a type called stablecoins. Cryptos were bought and sold either on centralized exchanges (CEXs)—such as Binance, Coinbase, Gemini, and Kraken— or on DEXs—such as Curve, Thorchain, and UniSwap. DEXs were not subject to the same oversight as traditional exchanges, such as the New York Stock Exchange. CEXs typically required users to place assets in their custody before trading.8 Bitcoin (BTC), the world’s first crypto and not a stablecoin, was introduced in 2009 and available to buy, sell, and trade on online crypto exchanges in 2010. BTC was created to be a peer-to- peer cash system. Unlike traditional currency, BTC was not backed by a government or a central bank; while government backing did not eliminate volatility risk, especially in emerging markets, arguably it provided investors with some measure of safety compared to BTC, which had no intrinsic value and was backed by nothing.

6 Campbell R. Harvey, Ashwin Ramachandran, and Joseph Santoro, DeFi and the Future of Finance (Hoboken, NJ: John Wiley & Sons, Inc., 2021). 7 Harvey, Ramachandran, and Santoro, DeFi and the Future of Finance. 8 Benedict George, “Centralized Exchange (CEX) vs. Decentralized Exchange (DEX): What’s the Difference?,” CoinDesk, August 5, 2022,

https://www.coindesk.com/learn/centralized-exchange-cex-vs-decentralized-exchange-dex-whats-the-difference/ (accessed Nov. 1, 2022).

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Consequently, the value of cryptos that were not stablecoins had been subject to wild swings rendering them unreliable means of payment.9 In 2018, the value of a BTC, for example, fell from around $20,000 to $3,000.10 Volatility led to more innovation with the introduction of the first stablecoins in 2014. Stablecoins were created to offer the features of cryptos (i.e., instant transfers and low fees) without the volatility. In theory, this meant investors avoided wild swings in the value of their portfolios. By early 2022, there were roughly 200 stablecoins worldwide, a mere fraction of the more than 10,000 total cryptos in existence.11 (See Exhibit 2 for the top 12 cryptos by market value in September 2022).

Stablecoins were considered the bedrock of DeFi trading and lending.12 More than 90% of trading volume in cryptos occurred in stablecoins.13 Stablecoins were widely used to move funds between different cryptos or into regular cash. Members of the Monetary and Economic Department of the Bank for International Settlements (BIS) wrote,

Initially, stablecoins evolved in order to address the failure of Bitcoin and other cryptocurrencies to provide an effective monetary and payment instrument. This reflected the preference of main market participants to base transactions and payments on sovereign fiat currencies [i.e., government issued and backed], in particular the US dollar. It also reflected weaknesses in Bitcoin and other cryptocurrencies inter alia as means of payment, store of value or unit of account. However, as no digital form of the dollar or other sovereign fiat currencies was available, market participants developed the stablecoin structure as a means to address this issue, as well as to provide an instrument to support hedging between crypto-assets and fiat currencies. The need was for a bridge between DLT (digital ledger technology) and fiat currencies, with stablecoins seeking to fill this need. This was particularly relevant in the context of high volatility in the price of Bitcoin, making it less useful as a payment instrument and more of an investment—speculative or otherwise—or hedge.14

Stablecoins were either asset-linked (centralized) or algorithm-based (decentralized). The business models and revenue streams of stablecoin companies varied depending on whether they were a centralized or decentralized stablecoin.

Asset-linked

Most stablecoins were asset-linked (centralized), meaning they were backed by a reserve pool of collateral— a fiat currency (e.g., US dollar), assets (e.g., bonds or commercial paper), or even other cryptos. In this model, which was the closer of the two to traditional structures in the financial services industry, stablecoins were collateralized off-chain, meaning the “backing” asset was held on the balance sheet or through third-party firms (e.g., banks).15 Created in 2014, Tether (USDT), was considered the first and largest stablecoin and was asset- linked backed by the US dollar, meaning an exchange rate of 1:1.16 In other words, for each USDT issued, Tether Holdings Limited Inc. (Tether), a blockchain company and issuer of USDT, should have $1 in reserves. Tether and many other of the biggest cryptos maintained a reserve of cash or cash-equivalent assets whose

9 Eswar Prasad, “Five Myths about Cryptocurrency,” Brookings, May 24, 2021, https://www.brookings.edu/opinions/five-myths-about- cryptocurrency/ (accessed Oct. 13, 2022).

10 Cale Guthrie Weissman, “What the Hell Happened to Crypto This Year?” Fast Company, December 21, 2018, https://www.fastcompany.com/90285052/beyond-the-bubble-what-happened-to-bitcoin-in-2018 (accessed Oct. 13, 2022).

11 Khristopher J. Brooks, “What Are Stablecoins, and How Do They Differ from Other Cryptocurrencies?,” CBS News, May 13, 2022, https://www.cbsnews.com/news/stablecoins-definition-cryptocurrency-cbs-news-explains/ (accessed Oct. 13, 2022).

12 Jack Denton, “How a Digital Token Designed to Be Stable Fueled a Crypto Crash,” Barron’s, May 16, 2022. 13 Denton, “How a Digital Token Designed to Be Stable Fueled a Crypto Crash.” 14 Douglas Arner, Raphael Auer, and Jon Frost, “Stablecoins: Risks, Potential and Regulation,” BIS working paper no. 905, November 2020,

https://www.bis.org/publ/work905.pdf (accessed Sept. 29, 2022). 15 “How Do Stablecoin Issuers Make Money?” PYMNTS, June 5, 2022, https://www.pymnts.com/cryptocurrency/2022/how-do-stablecoin-issuers-

make-money/ (accessed Oct. 2, 2022). 16 Tether issued several other fiat stablecoins (e.g., one pegged to gold).

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value in theory matched the total value of the stablecoin in circulation. That is, when a buyer paid Tether $1 for a USDT, that money was supposed to be held in Tether’s bank accounts. (Tether revealed in 2019 that it held billions of its reserve not in cash but in US commercial paper, which were riskier and less liquid than cash, especially during financial turmoil as was shown during the global financial crisis.)17 Because of its wide use to transfer digital assets into fiat currency and vice versa and transact between different platforms, USDT was described as “the reserve currency of the crypto world.”18 It facilitated billions of dollars’ worth of trades every day. In times of high volatility in cryptos, investors often put their cash into USDT. On May 7, 2022, the market cap of USDT was $83.2 billion.19

Asset-linked stablecoin companies made money through short-term lending and investing. Companies used their reserve assets and lent them out to others earning interest, counting on the unlikelihood that a large number of stablecoin holders would redeem their collateral at once.20 Tether, for example, loaned $1 billion to Celsius in October 2021, at an annual interest rate of 5% to 6%.21 Asset-linked stablecoin companies also generated revenue by charging issuance and redemption fees, although fees were relatively small (Tether charged a 0.1% redemption fee and had a minimum withdrawal fee of $1,000 to discourage low-volume redemptions.)22

Algorithm-based

Algorithm-based (decentralized) stablecoins used algorithms to increase or decrease the stablecoin supply in reaction to demand.23 “The decentralized model uses smart contracts, the cryptos themselves or algorithms to keep that ‘peg’ in place, where a 1:1 relationship relies not on the traditional custodians, but on constant rebalancing of supply and demand.”24 TerraUSD (UST) was a leading algorithmic stablecoin (with nearly a $19 billion market cap at its peak on May 5, 2022) on the Terra blockchain.25 In theory, its peg was maintained by an automated arbitrage mechanism linked to a sister token, LUNA, a free-floating Terra coin. A UST could be exchanged for $1 worth of LUNA by burning the stablecoin and minting LUNA.26 Whenever either of them was exchanged, they were taken out of the circulation by the smart contracts programmed to maintain the system.27

It was “a complex mechanism involving swapping UST coins with LUNA, a free-floating crypto control supply.” (See Exhibit 3.) UST and LUNA were both on the Terra blockchain. “To entice traders to burn LUNA to create [UST], creators offered an insane 19.5% yield on staking—which is essentially crypto terminology for earning 19.5% interest on a loan—through what they called the Anchor Protocol,” wrote an observer.28 Terraform Labs had created DeFi project Anchor, a savings platform, in 2020. DeFi projects were software protocols running on top of a blockchain network. Investors remained in full control of their cryptos, but they did devolve or cede all their power of executing transactions to smart contracts.

17 Gillian Tett, “Stablecoin Investors May Be Due a Wake-Up Call,” Financial Times, October 14, 2021. 18 Tett, “Stablecoin Investors May Be Due a Wake-Up Call.” 19 “Tether,” Coin Market Cap, 2022, https://coinmarketcap.com/currencies/tether/ (accessed Oct. 22, 2022). 20 Sungyu Kwon, “How Do Stablecoins Make Money?,” Benzinga, June 2, 2022, https://www.benzinga.com/money/how-do-stablecoins-make-

money (accessed Sept. 30, 2022). 21 https://www.benzinga.com/money/how-do-stablecoins-make-money. 22 https://www.benzinga.com/money/how-do-stablecoins-make-money. 23 https://www.bis.org/publ/work905.pdf. 24 https://www.pymnts.com/cryptocurrency/2022/how-do-stablecoin-issuers-make-money/. 25 Created by South Korea’s Terra Labs, which was founded in 2018. 26 https://www.pymnts.com/cryptocurrency/2022/how-do-stablecoin-issuers-make-money/. 27 Muyao Shen, “How $60 Billion in Terra Coins Went up in Algorithmic Smoke,” Bloomberg, May 21, 2022,

https://www.bloomberg.com/graphics/2022-crypto-luna-terra-stablecoin-explainer/ (accessed Oct. 14, 2022). 28 Daniel Van Boom, “Luna Crypto Crash: How UST Broke and What’s Next for Terra,” CNET, May 25, 2022, https://www.cnet.com/personal-

finance/crypto/luna-crypto-crash-how-ust-broke-and-whats-next-for-terra/ (accessed Oct. 1, 2022).

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Risk to the financial system

Regulators in the United States and abroad had grown increasingly concerned that stablecoins could pose a systemic risk to financial systems. US Treasury Secretary Janet Yellen said as much. “They present the same kind of risks that we have known for centuries in connection with bank runs,” Yellen told congressional leaders, urging Congress to approve federal regulation of stablecoins by the end of 2022.29 European Central Bank executive board member Fabio Panetta echoed Yellen’s concerns. The European Union was planning new rules known as the Markets in Crypto-Assets Regulation (MiCA) to regulate stablecoins.30 The chair of the Financial Times US editorial board wrote,

Should the mainstream financial world care? Some seasoned performers might argue not. After all, stablecoins currently act somewhat like the poker chips of a cyber casino. While the tokens are used to make trades within the confines of crypto-land, they can only be used there. As a result it should not matter if they turn out, say, to be part of a pyramid scheme, as long as that casino is self contained— or so the optimistic argument goes. Yet that idea seems more and more naive. For one thing, mainstream investors and institutions are increasingly being pulled into the crypto world, for investment purposes, if nothing else. For another, the market now has tentacles into other parts of finance, as Tether’s holdings of US commercial paper shows. This might create contagion risk, as Fitch ratings noted…particularly if these products are combined with the type of leverage that might spark margin calls in a crunch (which they increasingly are).31

Lending Platforms

Unlike traditional banks, crypto lending companies were not overseen by financial regulators. For example, rules on capital requirements or transparency of reserves were nonexistent, meaning depositors faced risks of losing their funds in addition to risks associated with volatility in crypto markets that affected the value of cryptos they had loaned out. Crypto lending platforms were either decentralized (DeFi) or centralized (CeFi).

Decentralized

DeFi lending platforms matched savers and borrowers, peer-to-peer, entirely on an algorithm and used smart contracts to execute the transaction. Anyone who had access to the platform could provide cryptos to lend out or borrow without either party required to identify themselves. Depositors made money by lending their cryptos, typically receiving between a 5% and 10% interest rate, to investors or crypto companies for speculation, hedging, or as working capital. “DeFi lending platforms allowed [borrowers] to deposit collateral in the form of crypto assets and receive assets, typically dollar-denominated stablecoins, in return…Borrowers often take out DeFi loans to retain exposure to price movements in the collateral they post, while using the loan to purchase other assets or to finance consumption (similar to taking out a margin loan against a stock portfolio).”32 In addition, “Rates on DeFi platforms typically exceed those offered by banks on retail deposits because the lender was taking more risk, and the borrower expected to make higher rates of return on speculative crypto asset investments.”33 Normally, borrowers had to secure loans with collateral in cryptos and were limited to borrowing an amount typically less than the full value of the collateral. 34 Despite this

29 Ryan Browne, “Regulators Are Getting Nervous about Stablecoins after Terra’s Stunning Collapse,” CNBC, May 13, 2022, https://www.cnbc.com/2022/05/13/regulators-anxious-about-stablecoins-like-tether-after-ust-collapse.html (accessed Oct. 2, 2022).

30 Ryan Browne, “Investors Withdraw over $7 Billion from Tether, Raising Fresh Fears about Stablecoin’s Backing,” CNBC, May 17, 2022, https://www.cnbc.com/2022/05/17/tether-usdt-redemptions-fuel-fears-about-stablecoins-backing.html (accessed Oct. 1, 2022).

31 Tett, “Stablecoin Investors May Be Due a Wake-Up Call.” 32 Carapella et al., “Decentralized Finance (DeFi): Transformative Potential & Associated Risks.” 33 Carapella et al., “Decentralized Finance (DeFi): Transformative Potential & Associated Risks.” 34 Carapella et al., “Decentralized Finance (DeFi): Transformative Potential & Associated Risks.”

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overcollateralization, lending platforms faced exposures to fluctuations in the price of the underlying collateral asset.35 In a bulletin released in June 2022, the BIS wrote,

On one side are individual depositors (also known as lenders), who deposit (or “stake”) their crypto assets into so-called liquidity pools, earning a deposit rate. On the other side are the borrowers, who receive crypto assets and pay a borrowing rate. The two rates vary by crypto asset and are determined by the demand for loans and the size of the liquidity pool, which represents the supply of funds. For their services, platforms usually charge fees paid by the borrower. As the process is automated, loan disbursement is nearly instantaneous and associated costs are modest.36

Leading DeFi lending platforms included Aave, MakerDAO (which allowed investors to borrow DAI, MakerDAO’s decentralized stablecoin pegged to the US dollar), and Compound. All three launched in 2017.

Centralized

With CeFi lending platforms, an entity (either a standalone company or a crypto exchange with a lending platform) oversaw and facilitated the lending and borrowing process. Therefore, depositors and borrowers— both needed to register with the platform—making them the customers, much like with traditional banks. CeFi lending platforms did not use blockchains or smart contracts and did not connect parties peer-to-peer, but rather pooled crypto deposits and then loaned them out to borrowers.

Banks Are Not Your Friends

In 2017, CEO Alex Mashinsky and Daniel Leon founded Celsius, a lending platform for cryptos including stablecoins, with the idea to disintermediate the financial system. “We live in a peer-to-peer society where we no longer need the support of global financial institutions to conduct our everyday lives,” said Mashinsky, who on occasion would wear a black T-shirt imprinted with “Banks are not your friends.” in white letters.37 Celsius was not a decentralized lending platform agnostic to its participants. “Celsius is not a neutral platform,” Mashinsky explained. “Our job every day is to represent the depositor…and extract as much as possible out of the borrower…institutions and hedge funds…We take money from these institutions; they pay us interest and we distribute it pro rata to the depositors.”38 According to Mashinsky, Celsius straddled both DeFi and CeFi. The company used smart contracts and open ledgers but also aggregated the custodial wallets that allowed borrowing and earning yield for its depositors.39 “Pure DeFi is not necessarily a good thing,” he said. “Because if you are pure DeFi, most people on the planet…cannot participate in DeFi. It is too hard for them. It is too difficult for them to understand the technology…how smart contracts behave…you are seeing this migration towards the middle.”40

Accessible to anyone with a smartphone, Celsius was a blockchain-integrated fintech platform that offered lending, yield creation, and payments solutions. Depositors (largely retail investors) could stake their cryptos on the platform, which accepted more than 35 cryptos, including BTC and Ether (ETH), and stablecoins like USDT.41

35 Carapella et al., “Decentralized Finance (DeFi): Transformative Potential & Associated Risks.” 36 Sirio Aramonte et al., “DeFi Lending: Intermediation without Information?” BIS Bulletin no. 57, June 14, 2022,

https://www.bis.org/publ/bisbull57.pdf (accessed Oct. 14, 2022). 37 “Celsius Network Launches Crypto-Backed Lending Platform,” CISION PR Newswire, March 16, 2018. 38“BlockDown 2.0 – DeFi vs CeFi – Alex Mashinsky X Rune Christensen,” YouTube video, 7:55, posted by “BlockDown TV,” June 26, 2020,

https://www.youtube.com/watch?v=K7H6evLGYXQ (accessed Oct. 13, 2022). 39 Alex Mashinsky, “The Best of Both Worlds: How Celsius Straddles Both CeFi and DeFi,” Medium, January 26, 2021,

https://mashinsky.medium.com/the-best-of-both-worlds-how-celsius-straddles-both-cefi-and-defi-d15325c61814 (accessed Oct. 13, 2022). 40 https://www.youtube.com/watch?v=K7H6evLGYXQ. 41 The currency of the Ethereum blockchain.

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There was no minimum amount of cryptos to stake to participate and no lockup period or penalty for withdrawing cryptos. Besides earning interest on their staked cryptos, depositors could also borrow US dollars using their staked cryptos as collateral. This allowed them to keep their cryptos while accessing fiat liquidity. These loans were overcollateralized, meaning their dollar amount was at most 50% of the collateral value.42

“The remaining untapped collateral acts as a buffer against crypto price fluctuations,” wrote Mashinsky.43

Because loans were collateralized, they were executed in minutes.

Depositors received weekly interest payments at generous annual rates, dependent on the crypto deposited.44 Rates changed weekly based on market conditions (e.g., borrowing demand for a specific crypto). BTC deposits earned around 3% to 8%, ETH 4% to 7%, and USDT 9% to 11%, while the top rate of 18% went to deposits of Synthetix Network (SNX), a protocol that enabled the issuance of synthetic assets on the Ethereum blockchain.45 Moreover, depositors received the highest range of the aforementioned rates if they accepted yields in Celsius’s own token called CEL. The CEL’s initial coin offering (ICO) in 2018 raised $50 million, with CEL valued at $0.30 per token.46 “Initially, only 50% of the tokens were issued, with 25% going to the founding team and the remaining locked in a smart contract,” wrote Mashinsky.47 By receiving interest for the cryptos they lent, depositors could earn up to 30% if they took their interest in CEL. Meanwhile, by paying interest in CELs, borrowers could receive discounts up to 30% on their interest payments.48 The benefits to the lender or the borrower depended on the amount of CELs they held on the platform (see Table 1).

Table 1. Celsius rewards.

Reward Status CEL Ratio CEL Balance Bonus Rewards Loan Interest Discount

Bronze 5%–10% or 1 10% 5%

Silver 10%–15% or 1,000 15% 10%

Gold 15%–25% or 10,000 20% 15%

Platinum 25%–100% or 25,000 30% 25%

Source: Celsius, 2022, https://celsius.network/cel-token-explained (accessed Nov. 1, 2022).

Celsius was the biggest holder of CEL and included those holdings as an asset on its balance sheet. It was also a major buyer of the token, purchasing the CEL interest it owed to customers on the open market each week.49 Celsius did not consider CELs to be a security under applicable laws but wrote, “due to regulatory uncertainty, we are taking precautionary action and treating CEL tokens as though they might be viewed as a security by U.S. financial authorities in the future.”50

While depositors earned substantially more than what they would earn if they had deposited the cash equivalent of their cryptos in a bank, they did run the risk that the value of the crypto could drop, as they were

42 Alex Mashinsky, “What Is the Celsius Network?,” Gemini, January 14, 2022, https://www.gemini.com/cryptopedia/celsius-network-token-cel (accessed Oct. 14, 2022).

43 https://www.gemini.com/cryptopedia/celsius-network-token-cel. 44 Zeke Faux and Joe Light, “Celsius’s 18% Yields on Crypto Are Tempting—and Drawing Scrutiny,” Bloomberg, January 27, 2022,

https://www.bloomberg.com/news/articles/2022-01-27/celsius-s-18-yields-on-crypto-are-tempting-and-drawing-scrutiny (accessed Sept. 29, 2022). 45 https://www.bloomberg.com/news/articles/2022-01-27/celsius-s-18-yields-on-crypto-are-tempting-and-drawing-scrutiny. 46 Ivanontech, “What Is Celsius Network and CEL Token?,” Academy, January 28, 2021, https://academy.moralis.io/blog/what-is-celsius-network-

and-the-cel-token (accessed Nov. 1, 2022). 47 https://www.gemini.com/cryptopedia/celsius-network-token-cel. 48 https://www.gemini.com/cryptopedia/celsius-network-token-cel. 49 Kadhim Shubber and Joshua Oliver, “Inside Celsius: How One of Crypto’s Biggest Lenders Ground to a Halt,” Financial Times, July 13 2022,

https://www.ft.com/content/4fa06516-119b-4722-946b-944e38b02f45 (accessed Oct. 13, 2022). 50 “Accredited Investor FAQs,” Celsius Network website, June 2022, https://support.celsius.network/hc/en-us/articles/4406861138961-

Accredited-Investor-FAQ#:~:text=Celsius%20does%20not%20consider%20CEL,financial%20authorities%20in%20the%20future (accessed Nov. 1, 2022).

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not covered by federal deposit insurance. The company claimed it could pay such high rates to depositors because “it invests the deposits and earns even bigger returns, in part by lending cryptocurrency to traders, who are willing to pay high rates to use it for bets.”51 Indeed, Celsius pooled all the crypto deposits and lent them to institutional investors with interest. “There’s a lot of confusion about where yield comes from,” Mashinsky said. “Celsius generates a certain amount of profit by lending assets, similar to what banks do. We lend them out on a short-term basis. These are not loans. We lend financial assets to players that can transact and generate income for themselves through arbitrage, market making or shorting certain stocks or digital assets.”52 He claimed Celsius returned 80% of its earnings to depositors in the form of rewards and attractive interest rates. “But how does Celsius afford to do this?” Mashinsky added. “The key lies in the over-collateralization of crypto loans and rehypothecation, a process by which crypto funds held as collateral on the Celsius Network are lent to another party—in this case, large investors looking for reliable inroads into cryptocurrency.”53

In December 2021, Celsius raised $600 million in equity fundraising led by two investors—Canada’s second-largest pension fund Caisse de dépôt et placement du Québec and US investment group WestCap. At the time. Celsius was valued at $3 billion.54

Investing in DeFi projects

While Celsius made money by the spread between the interest rates borrowers paid and the interest rates the company paid to its depositors, it also began lending to medium-to-high risk DeFi projects using pooled deposits to generate high yields. “The shift to higher-risk strategies was likely thanks to increased deposits in response to its high yield offerings, combined with declines in institutional interest as the crypto market started to cool in late-2021,” posited one crypto columnist.55

For example, Celsius invested in Anchor, which was a “sort of crypto bank” established by Terraform Labs, the issuer of UST. Anchor, a blockchain-based protocol, offered returns of nearly 20% on deposits and invested mostly in UST. In the June 2020 Anchor whitepaper, the authors wrote,

Anchor is a savings protocol that accepts Terra deposits, allows instant withdrawals and pays depositors a low-volatility interest rate. To generate yield, Anchor lends out deposits to borrowers who put down liquid-staked PoS [proof of stake] assets from major blockchains as collateral (bAssets). Anchor stabilizes the deposit interest rate by passing on a variable fraction of the bAsset yield to the depositor. It guarantees the principal of depositors by liquidating borrowers’ collateral via liquidation contracts and third-party arbitrageurs.56

Lending to DeFi had a different risk profile than lending to institutional borrowers. “On the one hand, there is smart contract risk, there is protocol risk,” said the head of research at a crypto investment bank. “Also, lending in DeFi exposes you significantly to volatile market moves…[The risk] isn’t the same as relying on

51 https://www.bloomberg.com/news/articles/2022-01-27/celsius-s-18-yields-on-crypto-are-tempting-and-drawing-scrutiny. 52 Oliver Knight, “How Crypto Lender Celsius Overheated,” CoinDesk, June 16, 2022, https://www.coindesk.com/business/2022/06/16/how-

crypto-lender-celsius-overheated/ (accessed Feb. 13, 2023). 53 https://www.gemini.com/cryptopedia/celsius-network-token-cel. 54 Kadhim Shubber, “Alex Mashinsky Took Control of Celsius Trading Strategy Months before Bankruptcy,” Financial Times, August 16, 2022.

David Morris, “Satoshi Wept: How Crypto Replayed the 2008 Financial Crisis,” CoinDesk, July 12, 2022, https://www.google.com/search?q=David+Morris%2C+%E2%80%9CSatoshi+Wept%3A+How+Crypto+Replayed+the+2008+Financial+Crisis% 2C%E2%80%9D+CoinDesk%2C+July+12%2C+2022.&rlz=1C1GCEB_enUS868US874&oq=David+Morris%2C+%E2%80%9CSatoshi+Wept%3 A+How+Crypto+Replayed+the+2008+Financial+Crisis%2C%E2%80%9D+CoinDesk%2C+July+12%2C+2022.&aqs=chrome..69i57.3899j0j15&s ourceid=chrome&ie=UTF-8 (accessed Feb. 13, 2023).

56 Nicholas Platis, Eui Joon Lee, and Marco Di Maggio, “Anchor: Gold Standard for Passive Income on the Blockchain,” Anchor, June 2020, https://www.anchorprotocol.com/docs/anchor-v1.1.pdf (accessed Oct. 23, 2020).

55

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crypto market prices to sustain or grow…putting customer assets in DeFi markets is significantly riskier than lending on a secured basis to institutional counterparties.”57

Crypto Winter 2022

Just as the weather in spring 2022 was warming, DeFi was heading into what many later called a “crypto winter.” In November 2021, the worldwide market cap of cryptos [number of cryptos times their price] had peaked at $3 trillion.58 Over the next two months, a substantial investor sell-off skinned more than $1 trillion of value. Reasons for the selloff were myriad and included rising interest rates, inflation, and the possibility of increased regulation. By the end of March, cryptos had rebounded to a market cap of around $2.2 trillion, only to fall below $2 trillion in April.59 But the worst was yet to come (see Table 2).

Table 2. Worldwide crypto market capitalization, July 2010 to September 2020.

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

 

3,500

0

500

1,000

1,500

2,000

2,500

3,000

M ar ke t ca p it al iz at io n

(i n

b ill io n s U S d o lla rs )

Ju l 2 1 , 2 0 1 0

O ct

1 3 , 2 0 1 0

Ja n

0 5 , 2 0 1 1

M ar

3 0 , 2 0 1 1

Ju n

2 2 , 2 0 1 1

Se p

1 4 , 2 0 1 1

D ec

0 7 , 2 0 1 1

Fe b

2 9 , 2 0 1 2

M ay

2 3 , 2 0 1 2

A u g 1 5 , 2 0 1 2

N o v 0 7 , 2 0 1 2

Ja n

3 0 , 2 0 1 3

A p r 2 4 , 2 0 1 3

Ju l 1 7 , 2 0 1 3

O ct

0 9 , 2 0 1 3

Ja n

0 1 , 2 0 1 4

M ar

2 6 , 2 0 1 4

Ju n

1 8 , 2 0 1 4

Se p

1 0 , 2 0 1 4

D ec

0 3 , 2 0 1 4

M ar

1 1 , 2 0 1 5

Ju n

0 3 , 2 0 1 5

A u g 2 6 , 2 0 1 5

N o v 1 8 , 2 0 1 5

Fe b

1 0 , 2 0 1 6

M ay

0 4 , 2 0 1 6

Ju l 2 7 , 2 0 1 6

O ct

1 9 , 2 0 1 6

Ja n

1 1 , 2 0 1 7

A p r 0 5 , 2 0 1 7

Ju n

2 8 , 2 0 1 7

Se p

2 0 , 2 0 1 7

D ec

1 3 , 2 0 1 7

M ar

0 7 , 2 0 1 8

M ay

3 0 , 2 0 1 8

A u g 2 2 , 2 0 1 8

N o v 1 4 , 2 0 1 8

Fe b

0 6 , 2 0 1 9

M ay

0 1 , 2 0 1 9

Ju l 2 4 , 2 0 1 9

O ct

1 6 , 2 0 1 9

Ja n

0 8 , 2 0 2 0

A p r 0 1 , 2 0 2 0

Ju l 0 1 , 2 0 2 0

Se p

2 3 , 2 0 2 0

D ec

1 6 , 2 0 2 0

M ar

1 0 , 2 0 2 1

Ju n

0 2 , 2 0 2 1

A u g 2 5 , 2 0 2 1

N o v 1 7 , 2 0 2 1

Fe b

0 9 , 2 0 2 2

M ay

0 4 , 2 0 2 2

Ju l 2 7 , 2 0 2 2

Source: Adapted from https://www.statista.com/statistics/730876/cryptocurrency-maket-value/.

Over the course of three days (May 7–10), the situation deteriorated as investors fled from Anchor, thus destabilizing UST. One analysis of on-chain transactions found that 20 addresses made a total of 5,051 transactions withdrawing $2 billion UST from Anchor.60 Among those addresses was one belonging to Celsius. (One other on-chain analysis found that Celsius had invested more than $500 million in Anchor over the prior five months.)61 On May 9, UST broke its dollar peg (see Table 3).

57 https://www.coindesk.com/business/2022/06/16/how-crypto-lender-celsius-overheated/. 58 “Overall Cryptocurrency Market Capitalization per Week from July 2010 to September 2022,” Statista, September 29, 2022,

https://www.statista.com/statistics/730876/cryptocurrency-maket-value/ (accessed Oct. 20, 2022). 59 https://www.statista.com/statistics/730876/cryptocurrency-maket-value/. 60 Aurelie Barthere et al., “On-Chain Forensics: Demystifying TerraUSD De-peg,” Nansen, May 27, 2022, https://www.nansen.ai/research/on-chain-

forensics-demystifying-terrausd-de-peg (accessed Oct. 20, 2022). 61 Ryan Weeks, “Celsius Pulled Half a Billion Dollars out of Anchor Protocol Amid Terra Chaos,” Block, May 13, 2022,

https://www.theblock.co/post/146752/celsius-pulled-half-a-billion-dollars-out-of-anchor-protocol-amid-terra-chaos (accessed Oct. 22, 2022).

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Table 3. TerraUSD (UST) price, May 1, 2022, to May 15, 2022.

Date Open High Low Close Volume (millions)

5/1/2022 $1.000 $1.003 $0.998 $1.002 566.6

5/2/2022 $1.002 $1.003 $0.998 $1.001 574.2

5/3/2022 $0.999 $1.002 $0.998 $1.000 453.0

5/4/2022 $1.000 $1.002 $0.997 $0.999 612.3

5/5/2022 $1.001 $1.003 $0.998 $1.000 733.9

5/6/2022 $1.000 $1.003 $0.998 $1.000 649.6

5/7/2022 $1.000 $1.002 $0.993 $0.997 1,335.2

5/8/2022 $0.997 $1.000 $0.991 $0.996 2,025.9

5/9/2022 $0.995 $0.999 $0.793 $0.793 2,810.0

5/10/2022 $0.806 $0.949 $0.684 $0.800 4,906.0

5/11/2022 $0.799 $0.847 $0.300 $0.801 7,679.8

5/12/22 $0.801 $0.829 $0.363 $0.409 9,392.2

5/13/22 $0.406 $0.407 $0.133 $0.154 1,285.9

5/14/22 $0.162 $0.255 $0.148 $0.196 376.5

5/15/22 $0.196 $0.261 $0.170 $0.177 335.2

Source: Compiled from “TerraClassicUSD (UST-USD),” Yahoo! Finance, October 10, 2022, https://finance.yahoo.com/quote/UST USD/history/ (accessed Oct. 22, 2022).

Those withdrawals begat more withdrawals as investors took out around $5 billion over several days, more than one-third of Anchor’s total deposits, which were largely in UST.62 Most observers ascribed the withdrawals to investor jitters, while some floated that it was a premeditated attack by BlackRock and Citadel Securities to take down UST.63 With the promise of double-digit yields, investors had flocked to Anchor catapulting the circulating supply of UST from $2 billion to a high of $18.5 billion in a year, as investors needed UST to deposit.64 Critics had warned that Anchor’s high yield was unstainable “because interest revenue from borrows did not cover yield payouts and required an outside source to replenish the reserves.”65 One month after the UST broke its peg, the worldwide market cap of cryptos had lost around another $1 trillion dollars in value.66

“The huge sell-offs brought down the price of UST to $0.91, from $1,” wrote an observer. “As a result, traders started to change 90 cents worth of UST for $1 of Luna. Once a large amount of UST had been offloaded, the stablecoin started to depeg. In a panic, more people sold off UST, which led to the minting of more Luna and an increase in the circulating supply of Luna.”67

62 Krisztian Sandor, “Investors Flee Terra’s Anchor as UST Stablecoin Repeatedly Loses $1 Peg,” CoinDesk, May 9, 2022, https://www.coindesk.com/markets/2022/05/09/investors-flee-terras-anchor-as-ust-stablecoin-repeatedly-loses-1-peg/ (accessed Oct. 1, 2022).

63 Jon Sarlin, “Stablecoins Were Supposed to Be ‘Stable.’ Then the Crash Came,” CNN Business, May 17, 2022, https://www.cnn.com/2022/05/17/investing/luna-terra-losses-crypto-traders (Nov. 1, 2022).

64 https://www.coindesk.com/markets/2022/05/09/investors-flee-terras-anchor-as-ust-stablecoin-repeatedly-loses-1-peg/. 65 https://www.coindesk.com/markets/2022/05/09/investors-flee-terras-anchor-as-ust-stablecoin-repeatedly-loses-1-peg/. 66 https://www.statista.com/statistics/730876/cryptocurrency-maket-value/. 67 ‘What Really Happened to LUNA Crypto?,” Forbes, September 20, 2022, https://www.forbes.com/sites/qai/2022/09/20/what-really-happened-

to-luna-crypto/?sh=6bc8a41f4ff1 (accessed Oct. 20, 2022).

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In theory, when the market value of one UST was less than its $1 peg, investors were incentivized to trade one UST for $1 worth of LUNA (which could be more than or less than one LUNA depending on its market price at the time), taking the profit. This removed one UST from circulation, driving the value of the UST back up.68 When UST lost its peg, however, “arbitrageurs pounced, driving the price of LUNA into the floor,” according to one observer.69 “The system works only if traders actually want Luna. Investors did not want Luna when UST lost its peg this week,” said another. “They sold Luna in a panic.”70 Three days later, on May 12, the price of LUNA had fallen from $80 to a few cents. The collapse of Luna and UST cost investors $60 billion.71

“The UST-Luna exchange mechanism meant that the massive UST withdrawals led to a vast expansion in the supply of Luna, driving down its value even further.”72 (See Exhibit 4.)

Meanwhile, USDT fell briefly below its $1 peg (to as low as $0.95) amid panic over the UST collapse and questions over the existence and quality of the assets backing it one-to-one with the US dollar.73 By May 17, the circulating supply of USDT dropped from about $83 billion to less than $76 billion as investors withdrew more than $7 billion after UST briefly dropped from its $1 peg.74 (See Exhibit 5 for USDT price versus BTC.)

Crypto’s “Lehman Brothers” Moment

On June 17, 2022, Celsius froze its clients’ accounts. The company posted a memo to its clients, stating,

Due to extreme market conditions, today we are announcing that Celsius is pausing all withdrawals, Swap, and transfers between accounts. We are taking this action today to put Celsius in a better position to honor, over time, its withdrawal obligations…We are taking this necessary action for the benefit of our entire community in order to stabilize liquidity and operations while we take steps to preserve and protect assets.75

Celsius’s predicament echoed the troubles that took down Lehman Brothers in 2008 when the US housing bubble burst. The investment bank had been heavily invested in mortgage-backed securities (MBSs), which held subprime loans. As those loans began to default, the value of Lehman Brothers’ holdings in MBSs plummeted, forcing the firm to file bankruptcy and close its door permanently.

Celsius’s troubles predated the crypto collapse. In December 2021, it had lost $54 million of BTC, which the company had invested in BadgerDao, a DeFi platform, because of hackers.76 The company had also invested at least $450 million of customers’ ETH in Lido Finance, a DeFi platform that offered investors an opportunity to make money from a new version of ETH under development, known as “staked Ether” (stETH).77 One stETH was supposed to be redeemable for one ETH. But stETH’s price dropped compared

68 https://www.bloomberg.com/graphics/2022-crypto-luna-terra-stablecoin-explainer/. 69 https://www.pymnts.com/cryptocurrency/2022/how-do-stablecoin-issuers-make-money/. 70 Peter Weber, “The Stablecoin Cryptocurrency Crash, Explained,” Week, June 17, 2022, https://theweek.com/briefing/1014448/the-stablecoin-

cryptocurrency-crash-explained (accessed Feb. 13, 2023). 71 Wayne Duggan and Farren Powell, “What Is Celsius? Why Is It Crashing the Crypto Market?,” Forbes, July 18, 2022,

https://www.forbes.com/advisor/investing/cryptocurrency/what-is-celsius/ (accessed Oct. 2, 2022). 72 https://www.bloomberg.com/graphics/2022-crypto-luna-terra-stablecoin-explainer/. 73 In 2021, New York’s attorney general fined Tether $18.5 million, claiming it had lied about its reserves and calling it “a stablecoin without stability.”

David Yaffe-Bellany, “The Coin that Could Wreck Crypto,” New York Times, June 17, 2022, https://www.nytimes.com/2022/06/17/technology/tether- stablecoin-cryptocurrency.html#:~:text=In%202021%2C%20New%20York's%20attorney,as%20a%20loosely%20regulated%20bank (accessed Dec. 18, 2022).

74 https://www.cnbc.com/2022/05/17/tether-usdt-redemptions-fuel-fears-about-stablecoins-backing.html. 75 “A Memo to the Celsius Community,” Celsius, June 12, 2022, https://celsiusnetwork.medium.com/a-memo-to-the-celsius-community-

59532a06ecc6 (accessed Oct. 2, 2022). 76 Hannah Lang et al., “How Crypto Lender Celsius Stumbled on Risky Bank-Like Investments,” REUTERS, June 15, 2022,

https://www.reuters.com/business/finance/how-crypto-lender-celsius-stumbled-risky-bank-like-investments-2022-06-15/ (accessed Sept. 29, 2022). 77 “Lido’s $stETH in a Rough Patch Starts to De-peg,” CoinCodeCap, June 11, 2022, https://coincodecap.com/lidos-steth-in-a-rough-patch-starts-

to-de-peg (accessed Nov. 7, 2022).

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to ETH; the crypto market fall prompted holders to dump their stETH. According to a former Celsius executive, the company’s biggest failure was in its risk management practices when it came to investing in DeFi projects.78 Outside of the company’s lending to DeFi projects, Mashinsky also became directly involved with Celsius’s trading activities over fears of a crypto downturn. (Celsius’ trading desk largely operated manually on the exchanges it used.)79 For example, Mashinsky ordered the sale of millions of BTC expecting to buy it back at a lower price; however, the price did not fall, thus losing the company money.80 Meanwhile, the price of the CEL dropped more than 50% on the news of the withdrawal freeze. (See Exhibit 6.)

Ankram Intelligence, a crypto intelligence firm, analyzed Celsius’s situation and concluded, “Celsius was one of the biggest players in DeFi, accounting for a huge portion of the funds deployed to the three largest [lending] DeFi protocols, Compound, Aave, and Maker.”81 Ankram analysts wrote,

Celsius appears to have managed a notable portion of its assets more like a hedge fund than a bank, investing deposits aggressively in the crypto markets rather than lending them out in a low-risk manner to sophisticated institutions. Because Celsius is a centralized company, much of its balance sheet exists off-chain, leaving only Celsius with the complete picture. Yet a careful analysis of the on-chain data still provides valuable insight into Celsius’ operations…[It] had billions of dollars in leveraged positions on decentralized finance (DeFi) protocols that were threatened with liquidation in the June crypto market crash…to avoid liquidation, it appears Celsius was forced to deploy $750 million of liquid assets that could no longer be used to meet withdrawal obligations. Celsius’ decision to take these leveraged positions may have played a critical role in [its] decision to pause user withdrawals, swaps and transfers.82

In bankruptcy court filings in July 2022, Celsius said it had more than 100,000 creditors, some 23,000 outstanding loans to retail borrowers worth $411 million, which were backed by crypto collateral worth $766 million.83 Celsius listed its largest 50 creditors, without mention of the order in which they would be repaid.84 Many of its 1.7 million clients were individual investors.85 (See Exhibit 7 for Celsius assets and liabilities.) One industry executive called Celsius the Lehman Brothers of 2022, writing,

The collapse [for both] came because of a desire to keep up with the competition and get more and more clients, which pushed risk management beyond the reasonable limits of the sector…one of the amazing things is that because everything is done on a blockchain infrastructure, there is a high level of transparency—and this is in contrast to Lehman Brothers, where everything suddenly exploded out of nowhere. Companies that monitor and analyze what is done on the blockchain saw that Celsius has a locked position in smart contracts, and started saying that this position is stuck because there is no liquidity there. Then the rumor started running on Twitter that they haven’t been liquid for six months, and that if you try to withdraw you will not receive the coins. This is also one of the biggest mistakes

78 Kate Rooney et al., “Former Employees Say Issues Plagued the Crypto Company Celsius Years ahead of Bankruptcy,” CNBC, July 19, 2022, https://www.cnbc.com/2022/07/19/former-employees-say-issues-plagued-crypto-company-celsius-years-before-bankruptcy.html (Oct 1. 2022).

79 Kadhim Shubber and Joshua Oliver, “Inside Celsius: One of Crypto’s Biggest Lenders Having a ‘Lehman Brothers Moment,’” Financial Times, July 13, 2022.

80 Shubber, “Alex Mashinsky Took Control of Celsius Trading Strategy Months before Bankruptcy.” 81 “Report on the Celsius Network,” Arkham Intelligence, July 7, 2022, https://www.arkhamintelligence.com/reports/celsius-report (accessed Oct.

14, 2022). 82 “https://www.arkhamintelligence.com/reports/celsius-report. 83 “Analysis: Clients of Crypto Lender Celsius Face Long Wait over Fate of Their Funds,” Reuters, July 18, 2022,

https://www.reuters.com/technology/clients-crypto-lender-celsius-face-long-wait-over-fate-their-funds-2022-07- 15/#:~:text=WASHINGTON%2FLONDON%2C%20July%2015%20(,in%20crypto%20markets%20this%20year (accessed Feb. 13, 2023).

84 https://www.reuters.com/technology/clients-crypto-lender-celsius-face-long-wait-over-fate-their-funds-2022-07- 15/#:~:text=WASHINGTON%2FLONDON%2C%20July%2015%20(,in%20crypto%20markets%20this%20year.

85 https://www.reuters.com/technology/clients-crypto-lender-celsius-face-long-wait-over-fate-their-funds-2022-07- 15/#:~:text=WASHINGTON%2FLONDON%2C%20July%2015%20(,in%20crypto%20markets%20this%20year.

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of the Celsius people: they entered positions too openly, and everyone could see their trade. If no one knew, the withdrawal panic would not have occurred. At Lehman Brothers, only the elite knew.86

On September 27, 2022, Mashinsky resigned. It was then reported that FTX, a crypto exchange, led by crypto billionaire Sam Bankman-Fried, was reconsidering bidding on Celsius’s assets. FTX had bid and won the rights to acquire Voyager Digital, another recently bankrupt crypto lender. In July, FTX provided a $250 million line of credit to troubled lender BlockFi, which included an option to buy.87 FTX had previously shown interest in Celsius in July, but an examination of the company’s financials then scared it away.

On November 11, 2022, FTX, once valued as high as $32 billion, filed for bankruptcy.88 On December 13, 2022, the US Department of Justice charged Bankman-Fried with “defrauding customers of FTX.com, investors in FTX.com, and lenders to Alameda Research.”89 Almeda Research was a quantitative trading firm, not unlike a hedge fund privately held by Bankman-Fried. According to one report, Bankman-Fried started FTX in 2019 to bring in revenue to fund Almeda.90 It was alleged that Bankman-Fried used customers’ deposits in FTX to prop up Almeda. In December 2023, the US Securities and Exchange Commission (SEC) filed civil charges against Bankman-Fried. In its press release, the SEC wrote,

…Bankman-Fried orchestrated a years-long fraud to conceal from FTX’s investors (1) the undisclosed diversion of FTX customers’ funds to Alameda Research LLC, his privately-held crypto hedge fund; (2) the undisclosed special treatment afforded to Alameda on the FTX platform, including providing Alameda with a virtually unlimited “line of credit” funded by the platform’s customers and exempting Alameda from certain key FTX risk mitigation measures; and (3) undisclosed risk stemming from FTX’s exposure to Alameda’s significant holdings of overvalued, illiquid assets such as FTX-affiliated tokens.91

In early January 2023, New York’s attorney general filed a lawsuit against Mashinsky accusing the former CEO of defrauding investors. In the filing, the attorney general’s office wrote,

Mashinsky promoted Celsius as a safe alternative to banks while concealing that Celsius was actually engaged in risky investment strategies…. In hundreds of interviews, blog posts, and livestreams, Mashinsky promised investors high yield with minimal risk, assuring them that their digital assets would be as safe as money in a bank and that Celsius would always act in investors’ best interest. Touting himself and his company as a modern-day Robin Hood, Mashinsky boasted that Celsius “deliver[s] yield…to the people who would never be able to do, [and] we take it from the rich…” He told investors that Celsius would generate sustainably high returns by making low-risk collateralized loans to first-tier institutions and cryptocurrency exchanges as well as overcollateralized loans to retail borrowers. These promises were false–but proved wildly popular…. But as Celsius grew larger, it struggled to generate enough revenue to pay the promised yields on investors’ deposits. In search of revenue, Celsius moved into significantly riskier investments, extending hundreds of millions of dollars in uncollateralized

86 Sophie Shulman, “‘So, Celsius Collapsed. Lehman Also Collapsed and the Economy Didn’t Stop,’” CTECH, September 11, 2022, https://www.calcalistech.com/ctechnews/article/bj100114jlj (accessed Oct. 2, 2022).

87 Ryan Browne, “Bitcoin Billionaire Sam Bankman-Fried Bails out Embattled Crypto Firms BlockFi and Voyager,” CNBC, June 22, 2022, https://www.cnbc.com/2022/06/22/sam-bankman-fried-rescues-crypto-lenders-blockfi-voyager.html (accessed Oct. 2, 2022).

88 Emily Stewart, “FTX’s Implosion and SBF’s Arrest, Explained,” Vox, December 13, 2022, https://www.vox.com/the-goods/23451761/ftx-sam- bankman-fried-arrest-bankrupt-bitcoin-alameda (accessed Jan. 23, 2023).

89 “United States v. Samuel Bankman-Fried, a/k/a “SBF,” 22 Cr. 673 (LAK),” The United States Attorney’s Office, Southern District of New York, January 9, 2023, https://www.justice.gov/usao-sdny/united-states-v-samuel-bankman-fried-aka-sbf-22-cr-673-lak (accessed Jan 23, 2023).

90 Matthew Goldstein et al., “How FTX’s Sister Firm Brought the Crypto Exchange Down,” New York Times, November 18, 2022, https://www.nytimes.com/2022/11/18/business/ftx-alameda-ties.html (accessed Jan. 23, 2023).

91 “SEC Charges Samuel Bankman-Fried with Defrauding Investors in Crypto Asset Trading Platform FTX,” SEC Ligation Release No. 25616, January 19, 2023, https://www.sec.gov/litigation/litreleases/2023/lr25616.htm#:~:text=filed%20Dec.%2013%2C%202022),the%20CEO%20 and%20co%2Dfounder (accessed Jan. 23, 2023).

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loans, and investing hundreds of millions of dollars in unregulated decentralized finance platforms. When Celsius suffered losses on risky investments, Mashinsky failed to disclose these losses to investors. Instead, he continued to promise and pay high yields to attract new deposits and to tell investors to keep their cryptocurrency with Celsius which, he continued to promise, would invest it safely and pay better returns than the banks.92

In January 2023, there appeared to be no foreseeable end to the crypto winter. What it all meant to DeFi and the democratization of financial services was a large unknown. Was DeFi just something that was simply theoretical and not practical? Could it survive? What changes were necessary? And who owned those changes?

92 New York Attorney General’s complaint against Alex Mashinsky, Supreme Court of the State of New York, January 5, 2023, https://ag.ny.gov/sites/default/files/mashinsky_complaint.pdf (accessed Jan. 23, 2023).

For the exclusive use of C. Jimenez, 2024.

This document is authorized for use only by Carolina Jimenez in Fall 2024 – Financial Innovations taught by Florent Rouxelin, Florida International University from Aug 2024 to Dec 2024.

Page 15 UV8663

Exhibit 1

Crypto Winter Buries Celsius Network and Batters DeFi

TVL (Total Value Locked) Worldwide across Multiple DeFi Blockchains: November 2018 to June 26, 2022

Source: “TVL (Total Value Locked) across Multiple Decentralized Finance (DeFi) Blockchains from November 2018 to June 26, 2022,” Statista, 2022, https://www-statista-com.proxy01.its.virginia.edu/statistics/1272181/defi-tvl-in-multiple-blockchains/ (accessed Nov. 1, 2022).

Exhibit 2

Crypto Winter Buries Celsius Network and Batters DeFi

Top 12 Cryptos by Market Cap on September 23, 2022

Currency USD Billions 1 Bitcoin (BTC) $367.3 2 Ethereum (ETH) $161.9 3 Tether (USDT)* $68.0 4 USD Coin (USDC) $49.8 5 Binance Coin (BNB) $44.2 6 Ripple (XRP) $25.2 7 Binance (USD)* $20.5 8 Cardano (ADA) $15.7 9 Solana (SOL) $11.4 10 Dogecoin (DOGE) $8.0 11 Polkadot (DOT) $7.2 12 Dai (DAI)* $6.9

* Stablecoin.

Source: “Biggest Cryptocurrency in the World—Both Coins and Tokens—Based on Market Capitalization on September 23, 2022,” Statista, September 23, 2022, https://www.statista.com/statistics/1269013/biggest-crypto-per-category-worldwide/ (accessed Oct. 14, 2022).

For the exclusive use of C. Jimenez, 2024.

This document is authorized for use only by Carolina Jimenez in Fall 2024 – Financial Innovations taught by Florent Rouxelin, Florida International University from Aug 2024 to Dec 2024.

Page 16 UV8663

Exhibit 3

Crypto Winter Buries Celsius Network and Batters DeFi

Terra Network Tokens: TerraUSD (UST) and Luna (LUNA)

TerraUSD(UST) was a stablecoin that used a smart contract-based algorithm to keep its price anchored to $1 by burning (permanently destroying) LUNAs in order to mint (create) new TerraUSD (UST)s. In the Terra ecosystem, users could swap the LUNA for UST, and vice versa, at a guaranteed price of $1 regardless of their market price at the time. If demand for UST and its price rose above $1, LUNA holders could bank a risk-free profit by swapping $1 of LUNA to create one UST (which due to a rise in demand in this example, was worth more than $1). During the swapping process, a percentage of LUNA was burned (permanently removed from circulation) and the remainder was deposited into a community treasury. Funds in the treasury were then used to invest in applications and services that expanded the utility of the Terra ecosystem. Burning a percentage of LUNA tokens reduced the number of overall tokens in circulation, making them scarcer and, therefore, more valuable. Minting more UST had the effect of diluting the existing tokens in circulation and bringing the overall price back down to its $1 level. Similarly, if demand for UST was low and its price fell below $1, UST holders could exchange their UST at a ratio of 1:1 for LUNA–which was worth more because of their scarcity and so the user could bank another risk-free profit.

Source: Krisztian Sandor, “What Is LUNA and UST? A Guide to the Terra Ecosystem,” CoinDesk, May 9, 2022, https://www.coindesk.com/learn/what- is-luna-and-ust-a-guide-to-the-terra-ecosystem/ (accessed Oct. 1, 2022).

For the exclusive use of C. Jimenez, 2024.

This document is authorized for use only by Carolina Jimenez in Fall 2024 – Financial Innovations taught by Florent Rouxelin, Florida International University from Aug 2024 to Dec 2024.

Page 17 UV8663

Exhibit 4

Crypto Winter Buries Celsius Network and Batters DeFi

TerraUSD (UST) and LUNA Price Movement (in US dollars): August 11, 2021, to May 11, 2022

Sources: Adapted from “TerrraClassicUSD,” CoinMarketCap, 2022, https://coinmarketcap.com/currencies/terrausd/; and “Terra Luna Classic (LUNC),” CoinGecko, 2022, https://www.coingecko.com/en/coins/terra-luna-classic (accessed Dec. 18, 2022).

For the exclusive use of C. Jimenez, 2024.

This document is authorized for use only by Carolina Jimenez in Fall 2024 – Financial Innovations taught by Florent Rouxelin, Florida International University from Aug 2024 to Dec 2024.

Page 18 UV8663

Exhibit 5

Crypto Winter Buries Celsius Network and Batters DeFi

Tether (USDT) and Bitcoin (BTC) Prices (in US dollars): October 1, 2021, to September 29, 2022

Source: Adapted from “Tether,” CoinMarketCap, 2022, https://coinmarketcap.com/currencies/tether/ (accessed Oct. 1, 2022).

For the exclusive use of C. Jimenez, 2024.

This document is authorized for use only by Carolina Jimenez in Fall 2024 – Financial Innovations taught by Florent Rouxelin, Florida International University from Aug 2024 to Dec 2024.

Page 19 UV8663

Exhibit 6

Crypto Winter Buries Celsius Network and Batters DeFi

Celsius (CEL) Price (in US dollars): October 2, 2018, to October 1, 2022

Source: Adapted from “Celsius,” CoinMarketCap, 2022, https://coinmarketcap.com/currencies/celsius/ (accessed Oct. 1, 2022).

For the exclusive use of C. Jimenez, 2024.

This document is authorized for use only by Carolina Jimenez in Fall 2024 – Financial Innovations taught by Florent Rouxelin, Florida International University from Aug 2024 to Dec 2024.

Page 20 UV8663

Exhibit 7

Crypto Winter Buries Celsius Network and Batters DeFi

Celsius Network Assets and Liabilities

In millions of US dollars March 30, 2022 July 14, 2022 Change

Assets

Bank Cash $110 $170 $60

Other $520 $450 ($70)

Mining Assets $630 $720 $90

CEL Assets $2,210 $600 ($1,610)

Loans $4,080 $620 ($3,460)

Crypto Assets $14,560 $1,750 ($12,810)

Total $22,110 $4,310 ($17,800)

Liabilities

User Liabilities ($16,540) ($4,720) $11,820

CEL Liabilities ($870) ($210) $660

Other ($4,680) ($570) $4,110

Total ($22,090) ($5,500) $16,590

Surplus (deficit) $20 ($1,190)

USD Reduction in Assets billions $12.3 Decline in market value of holdings $1.9 User withdrawals $1.9 Loan redemption and liquidation $0.9 Crypto liquidated by third parties (Tether) $0.1 Crypto lost from investments $17.8 Total

Data sources: “Declaration of Alex Mashinksy, Chief Executive Officer of Celsius Network LLC, in Support of Chapter 11 Petitions and First Day Motions,” Case no. 22-10964, US Bankruptcy Court for Southern District of New York, July 14, 2022, https://pacer-documents.s3.amazonaws.com/115/312902/126122257414.pdf (accessed Nov. 1, 2022); and “In Re Celsius Network LLC,” Case no. 22-10964, US Bankruptcy Court for Southern District of New York, July 18, 2022, https://cases.stretto.com/public/x191/11749/PLEADINGS/1174907182280000000001.pdf (accessed Sept. 13, 2022).

For the exclusive use of C. Jimenez, 2024.

This document is authorized for use only by Carolina Jimenez in Fall 2024 – Financial Innovations taught by Florent Rouxelin, Florida International University from Aug 2024 to Dec 2024.