Celsius

Wrapped Bitcoin supply drops to negative after 11,500 wBTC burn linked to Celsius

Wrapped Bitcoin garnered DeFi traders’ support in the 2021–22 bull season, but the demand started to fade when numerous crypto contagions led to redemptions.

The supply of wrapped Bitcoin (wBTC) dropped to its lowest since May 2021 after the second-largest single-day burn on Feb. 27. 

A total of 11,500 wBTC ($260 million) linked to now-bankrupt crypto lender Celsius was burned, turning its growth rate negative. The current total supply of the wrapped token is 164,396 wBTC, with a monthly growth rate of -7.39%.

wBTC daily mint and burn. Source: Dune

WBTC is an Ethereum-based ERC-20 token that mirrors the value of Bitcoin and is pegged 1:1 with the price of Bitcoin (BTC). Bitgo co-developed wBTC in 2019 alongside blockchain interoperability protocol Ren and multichain liquidity platform Kyber. WBTC is managed by the decentralized autonomous organization wBTC DAO, which comprises over 30 members.

When merchants want to exchange BTC for wBTC, they start a burn transaction and alert the custodians. The merchant transfers real BTC to a custodian address on the Bitcoin blockchain, which is locked. Once it receives the real BTC, the custodian address mints the equivalent amount in wBTC on Ethereum.

Being an ERC-20 token makes the transfer of wBTC faster than normal Bitcoin, but the key advantage of wBTC is its integration into the world of Ethereum wallets, decentralized applications and smart contracts.

During the peak of the bull run, wrapped tokens became a popular tool of use in the decentralized finance ecosystem. WBTC’s supply peaked at 285,000 in April 2022, when the price of BTC was trading above $48,000.

However, with the advent of the bear market and numerous crypto contagions, the demand started to fade away. The first signs of lowering demand came after the Terra collapse, which forced several crypto lenders to redeem their wBTC. According to one report, Celsius Network redeemed about 9,000 wBTC amid a growing withdrawal demand.

Related: Celsius Network coin report shows a balance gap of $2.85 billion

A similar scenario occurred in November 2022 after the FTX collapse, where reports indicate the now-bankrupt crypto exchange tried redeeming 3,000 wBTC just before filing for bankruptcy. After the FTX collapse in November, wBTC experienced its largest monthly coin redemption, with over 28,000 wBTC redeemed back to the original coin.

The market contagion caused by the FTX collapse also depegged wBTC from the original value of BTC. Although the slippage was just about 1.5%, it raised serious concerns about whether such synthetic tokens were a viable mode of value transfer.

Crypto Biz: Celsius, FTX feel investors’ wrath as lawsuits multiply

Celsius creditors have filed a proposal to sue Alex Mashinsky, while creditors of FTX are turning their attention to the exchange’s venture backers.

The stunning collapses of Celsius and FTX destroyed many lives — early adopters who had the foresight to understand the unique value propositions of Bitcoin (BTC) and crypto were left with practically nothing when both platforms halted withdrawals, shuttered their doors and eventually filed for bankruptcy. While there’s still hope that creditors will be made partially whole again, the road to recouping financial losses is expected to be long. While they’re waiting, creditors are banding together to sue these firms for various alleged infractions. 

This week’s Crypto Biz delves into recent lawsuits targeting Celsius co-founder Alex Mashinsky and several venture capital firms that backed FTX during previous investment rounds. We also survey the latest news surrounding the United States Securities and Exchange Commission (SEC) and end on a positive note about a potential blockchain use case.

Celsius creditors committee proposes suing Mashinsky, other Celsius execs

Once the darling of yield-seeking crypto investors, bankrupt lending platform Celsius is accused of “fraud, recklessness, gross mismanagement and self-interested conduct” by former customers. In a complaint filed in a bankruptcy court on Feb. 14, attorneys representing Celsius’ creditors proposed to sue co-founder Alex Mashinsky and other former executives for such misdeeds. “Mr. Mashinsky, Mr. Leon, Mr. Goldstein, Mr. Beaudry, Ms. Urata-Thompson, and Mr. Treutler breached their fiduciary obligations to Celsius,” the lawyers wrote about Celsius’ executives. “Those parties were aware Celsius was promising its customer’s interest payments that it could not afford and did nothing to fix the problem.” It looks like Mashinsky’s problems are only just getting started.

Sequoia Capital, Paradigm among VCs facing ‘tricky’ FTX investor lawsuit

Customers of bankrupt crypto exchange FTX are turning their attention to the platform’s financiers and promoters to recoup some of the massive losses they’ve incurred. According to Bloomberg, FTX users have filed a class-action lawsuit against venture capital firm Sequoia Capital and private equity firms Thoma Bravo and Paradigm — all three companies were involved in FTX’s massive $900 million Series B round in July 2021. Meanwhile, a separate class-action lawsuit filed in California on Feb. 14 alleged that Silvergate Bank and its CEO Alan Lane were responsible for “aiding and abetting” Sam Bankman-Fried in carrying out his fraud. It looks like FTX’s venture capital and business backers are about to feel the blowback of the exchange’s failure.

SEC to target crypto firms operating as ‘qualified custodians’ — Report

The United States was always supposed to be a bedrock for innovation and first-mover advantage. In the case of crypto, however, regulators are coming down with an iron fist. In addition to stablecoins and staking protocols, the SEC is reportedly eyeing “qualified custodians” in its regulatory guidance and enforcement actions. According to Bloomberg, the SEC is working on a proposal that would make it difficult for crypto companies to serve as “qualified custodians” on behalf of clients. In practice, this may deter hedge funds and private equity funds from continuing to work alongside crypto custodians.

Siemens issues $64M digital bond on a public blockchain

Blockchain’s use cases may have extended to bond offerings after German engineering company Siemens issued a digital bond using distributed ledger technology. On Feb. 14, Siemens disclosed that it sold $60 million worth of digital bonds directly to investors, which included DekaBank, DZ Bank and Union Investment. The company said blockchain-based bonds have several advantages compared to traditional bond sales. “For instance, it makes paper-based global certificates and central clearing unnecessary,” Siemens said. “What’s more, the bond can be sold directly to investors without needing a bank to function as an intermediary.” It’s important to note that the bonds were still paid for using traditional methods because the digital euro is not yet available.

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Celsius bankruptcy judge authorizes the sale of $7.4M worth of Bitmain coupons

The judge’s ruling does not require Celsius debtors to sell the Bitmain coupons, which would need the consent of the committee of unsecured creditors.

Debtors for crypto lender Celsius Network have the authority to sell coupons for mining firm Bitmain coupons worth roughly $7.4 million following a ruling from a bankruptcy judge.

In a Feb. 16 court filing, United States Bankruptcy Judge Martin Glenn said it was in the “best interests of the Debtors’ estates, their creditors, and other parties” to allow Celsius debtors to sell their Bitmain coupons. The judge’s ruling does not require the debtors to liquidate the holdings in question, which would need the consent of the committee of unsecured creditors.

interim Celsius CEO Christopher Ferraro claimed in a Feb. 9 declaration that the debtors expected to sell the Bitmain coupons for roughly $7.4 million. According to Ferraro, the coupons allowed interested parties to buy Bitmain mining rigs with a 10% to 30% discount on future purchases.

“While $7.4 million is a significant discount from the Bitmain Coupons’ nearly $37 million face-value, the Debtors believe that such a price is commensurate with the market and preferable to the Bitmain Coupons expiring worthless in the Debtors’ possession,” Ferraro said at the time. “Based on the Debtors’ marketing efforts for the sale of similar assets, the Debtors anticipate that selling the Bitmain Coupons at a significant discount to their face-value is required.”

Celsius debtors’ holdings of Bitmain coupons as of Feb. 9.

Judge Glenn’s ruling followed debtors for the crypto lending firm presenting a restructuring plan on Feb. 15, in which Celsius chose NovaWulf Digital Management as a sponsor. The proposed plan had NovaWulf offering a direct cash contribution of between $45 million and 55 million to the newly restructured company.

Related: Celsius creditors committee proposes suing Mashinsky, other Celsius execs

Bankruptcy proceedings for major firms affected during the 2022 market crash are underway across courts in the United States. Crypto exchange FTX — facing scrutiny in bankruptcy court as well as being at the center of a criminal case in federal court — recently issued subpoenas to company insiders, including former CEO Sam Bankman-Fried.

Celsius chooses NovaWulf’s bid to exit from bankruptcy

Under the proposal by Celsius, most creditors would receive a one-time payment of crypto while those with larger claims would get equity in a new company.

Bankrupt crypto lender Celsius Network has chosen NovaWulf Digital Management as the sponsor for its proposed Chapter 11 restructuring plan, which will see the investment advisory firm take over the operations of a new company and most customers estimated to recover up to 70% of their funds.

Celsius presented the plan on Feb. 15 in a filing to the United States Bankruptcy Court for the Southern District of New York. The proposed plan has the support of the Celsius Official Committee of Unsecured Creditors (UCC) — a body representing the interests of Celsius account holders.

The plan sees the creation of a new public platform fully owned by Earn creditors called NewCo with the UCC appointing the majority of the company’s board members. The plan notes the new board will have no “Celsius founder involvement or relationship.”

NovaWulf will also make a direct cash contribution of between $45 million to $55 million to the new firm.

In the filing, Celsius said that “the NovaWulf plan provides the best method to distribute the Debtors’ liquid crypto assets and maximize the value of the Debtors’ illiquid assets through a new company run by experienced asset managers.”

The new company will house Celsius’ illiquid assets, mining business and existing loan portfolio with future plans to develop crypto-oriented services.

The key highlights and main points of the proposed plan for NewCo. Source: Stretto

Under the plan, creditors with claims valued $5,000 and below on the petition date will be placed in a “Convenience Class,” receiving “a one-time distribution of liquid crypto” paid in the form of Bitcoin (BTC), Ether (ETH) and USD Coin (USDC).

It’s estimated the option will provide over 85% of Celsius customers with around a 70% recovery of their deposited crypto. Any Earn creditor with a balance over $5,000 can elect to reduce a claim to $5,000 and participate in the class.

Celsius’ Earn creditor distribution plan. Source: Stretto

Those with a claim over $5,000 — or those with a claim of over $1,000 who opt out of the Convenience Class shares — will receive a payment of the residual crypto after the payments to smaller accounts.

In addition, they will receive ownership in NewCo through equity and management share tokens which will pay dividends to holders.

Earn users that hold Celsius (CEL) tokens, a native token used for user rewards that currently trades around $0.50, will be valued and purchased at the initial coin offering (ICO) price of $0.20.

The plan would see “insider CEL token claims,” or those buyers granted early ICO access, “receive no recovery.”

The plan also calls for the creation of a “well-funded litigation trust” to pursue lawsuits against Celsius executives and former CEO Alex Mashinsky.

The proposed plan will need approval from U.S. Bankruptcy Judge Martin Glenn before its enacted.

Six firms placed bids on Celsius crypto assets, including Binance, Bank To The Future, Cumberland DRW and Galaxy Digital from a process that saw Celsius contact “over 130 parties.”

The company filed for Chapter 11 bankruptcy in July 2022, after halting withdrawals citing “extreme market conditions” and rumors of insolvency.

Celsius creditors committee proposes suing Mashinsky, other Celsius execs

The proposed lawsuit names Alex Mashinsky and a number of former executives and co-founders for alleged “recklessness, gross mismanagement, and self-interested conduct.”

The official committee of Celsius creditors is proposing to sue Celsius co-founder Alex Mashinsky and other executives for “fraud, recklessness, gross mismanagement and self-interested conduct” that eventually led to the collapse of the crypto lender.

In a proposed complaint filed in a New York Bankruptcy Court on Feb. 14, attorneys representing the Official Committee of Unsecured Creditors said the move follows six months of investigations into Celsius’ current and former directors, officers and employees.

The committee is made up of seven Celsius account holders and was appointed by the U.S. Trustee in July. The committee represents the interest of Celsius account holders along with unsecured creditors.

“The Committee’s investigation has uncovered significant claims and causes of action based on fraud, recklessness, gross mismanagement, and self-interested conduct by the Debtors’ former directors and officers,” wrote lawyers from White & Case LLC.

The proposed lawsuit — which seeks damages in an amount to be proven at trial — aims to bring claims and causes of action against the following Celsius executives, persons and their associated entities:

  • Alex Mashinsky, co-founder, director and former CEO
  • Daniel Leon, co-founder, director and former CSO and chief operating officer
  • Hanoch “Nuke” Goldstein, co-founder and chief technology officer
  • Harumi Urata-Thompson, former chief financial officer and chief investment officer
  • Jeremie Beaudry, former general counsel and chief compliance office
  • Johannes Treutler, former head of Celsius’ trading desk and person in charge of purchasing CEL tokens on behalf of Celsius
  • Aliza Landes, the former vice president of Lending of Celsius and spouse of Daniel Leon
  • Kristine Mashinsky, the spouse of Alex Mashinsky

“Mr. Mashinsky, Mr. Leon, Mr. Goldstein, Mr. Beaudry, Ms. Urata-Thompson, and Mr. Treutler breached their fiduciary obligations to Celsius,” the lawyers wrote, adding:

“Those parties were aware Celsius was promising its customer’s interest payments that it could not afford and did nothing to fix the problem.”

The lawyers have also alleged the executives made “negligent, reckless (and sometimes self-interested) investments” causing Celsius to lose $1 billion in a single year, while mismanagement led to another quarter-of-a-billion dollar loss “because they could not adequately account for the company’s assets and liabilities.”

“After that loss, they did not invest in or develop the company’s systems to adequately fix the issue, resulting in further losses,” they alleged.

The motion also alleges the executives directed Celsius to spend “hundreds of millions of dollars” on public markets to inflate the price of CEL tokens, while they “secretly sold tens of millions of CEL tokens (or were aware of such sales)” for their own benefit.

Excerpt from the recent motion from Celsius’ official creditors committee. Source: Stretto

“They sat idly by as Mr. Mashinsky recklessly bet hundreds of millions of dollars on the movement of the cryptocurrency market. They covered up Mr. Mashinsky’s repeated lies about Celsius’ investments and financial condition.”

Related: Judge denies motions from Celsius users seeking to reclaim assets

“Finally, when it became apparent that Celsius would be required to file for bankruptcy, the Prospective Defendants withdrew assets from the sinking ship […] while actively encouraging customers to keep their assets on the Celsius platform,” the lawyers added.

The Celsius creditors committee said the proposed complaint was just the “first of many steps” in its investigation into potential former Celsius executive wrongdoings and the return of assets to victims.

A hearing on the proposed complaint will be held on March 8.

Cointelegraph contacted Celsius for comment but did not receive an immediate response.

Celsius‘ motion to extend timeline for restructuring plan faces objection from creditors

“It is time to allow the Debtors’ customers to propose their own plan for the assets that they were defrauded into investing with Celsius,” said a Withhold account holders’ filing.

The unsecured committee of creditors and others involved in crypto lending firm Celsius’ bankruptcy case have objected to a motion from the debtors delaying a reorganization plan.

In separate Feb. 8 court filings, the committee and Withhold account holders as well as the United States Trustee and Celsius borrowers objected to a motion aimed at extending the exclusivity period for a Chapter 11 restructuring plan from Feb. 15 to March 31. Under the proposed extension, Celsius’ debtors would also have the option of soliciting a plan until June 30.

The unsecured committee of creditors said the bankruptcy case “must proceed towards a resolution” based on the impact on Celsius users waiting months without access to their funds. Objections from the U.S. Trustee and Celsius borrowers claimed the bankruptcy was “consuming enormous amounts of professional fees” without guarantees of a resolution.

“Many account holders’ lives and finances have been upended because of the past conduct of the Debtors and certain of their former directors and officers,” said the committee’s filing.

Objections from Withhold account holders seemingly expressed similar frustration:

“Enough is enough. It is time to allow the Debtors’ customers to propose their own plan for the assets that they were defrauded into investing with Celsius. The Debtors’ exclusive right to control these cases must give way to the rights of the Debtors’ customers.”

Related: Judge denies motions from Celsius users seeking to reclaim assets

Celsius halted withdrawals for users in June 2022, with the firm filing for Chapter 11 bankruptcy in July. In December, Bankruptcy Judge Martin Glenn granted an extension for debtors to file a reorganization plan following a November motion, pushing the deadline to Feb. 15.

At the time, many affected Celsius users claimed the company was stalling proceedings with their funds in limbo, a sentiment echoed by the same group following the Feb. 8 objections:

At the time of its bankruptcy filing, Celsius reported a balance gap of $1.2 billion, with net liabilities of $6.6 billion and $3.8 billion in assets under management. However, reports later suggested that the lending platform’s actual debt was closer to $3 billion.

Bitcoin bulls plan to flip $23K to support by aiming to win this week’s $1B options expiry

BTC bulls are positioned to win this week’s $1 billion options expiry, but the market’s post-FOMC reaction could alter their plans.

Bitcoin’s (BTC) price has been trading above $22,500 for 12 days. Of course, this situation can change even if Federal Reserve chair Jerome Powell issues positive statements about the economy in today’s post-FOMC presser. 

Even if the decision matches the market consensus, the post-meeting statement should be investors’ primary area of focus. Specific areas to focus on would be clues for the next meeting in March.

Troubling news for the largest stablecoin Tether (USDT) could also cause a meaningful impact after a Celsius bankruptcy examiner report showed that “Tether’s exposure eventually grew to over $2 billion” in September 2021. However, it is unclear if iFinex — Tether’s issuer — suffered any losses. iFinex chief technology officer Paolo Ardoino denied exposure to Celsius and suggested that the examiner had “mixed up” prepositions in the report.

Is a strong correction in stock market ahead?

Legendary portfolio manager Michael Burry, known for being one of the most vocal critics of the subprime mortgage crisis from 2007 to 2008, posted a short note on Twitter on Feb. 1, suggesting that investors “sell.”

While the message lacks a supporting thesis, one could conclude that Burry expects a meaningful correction in traditional markets. Considering the 40-day correlation between Bitcoin and the S&P 500 index at 75%, the odds of a BTC price retrace become evident.

Consequently, this week’s $1 billion BTC options expiry on Feb. 3 can go either way because bears can still flip the tables even though the tide currently favors the bulls.

Bitcoin bears were caught entirely off-guard

The open interest for the Feb. 3 options expiry is $1 billion, but the actual figure will be lower since bears were caught by surprise after the 9.6% rally between Jan. 20 and Jan. 21.

Bitcoin options aggregate open interest for Feb. 3. Source: Coinglass

The 1.61 call-to-put ratio reflects the imbalance between the $640 million call (buy) open interest and the $400 million put (sell) options.

If Bitcoin price remains above $23,000 at 8:00 am UTC on Feb. 3, less than $7 million worth of these put (sell) options will be available. This difference occurs because the right to sell Bitcoin at $22,000 or $23,000 is useless if BTC trades above that level on expiry.

Related: Retail giant Pick n Pay to accept Bitcoin in 1,628 stores across South Africa

$23,000 Bitcoin would give bulls a $180 million profit

Below are the three most likely scenarios based on the current price action. The number of options contracts available on Feb.3 for call (bull) and put (bear) instruments varies, depending on the expiry price. The imbalance favoring each side constitutes the theoretical profit:

  • Between $21,000 and $22,000: 2,700 calls vs. 10,700 puts. The net result favors the put (bear) instruments by $165 million.
  • Between $22,000 and $23,000: 4,400 calls vs. 4,200 puts. The net result is balanced between call and put options.
  • Between $23,000 and $24,000: 7,800 calls vs. 100 puts. The net result favors the call (bull) instruments by $180 million.
  • Between $24,000 and $25,000: 12,400 calls vs. 0 puts. Bulls extend their gains to $300 million.

This crude estimate considers the call options used in bullish bets and the put options exclusively in neutral-to-bearish trades. Even so, this oversimplification disregards more complex investment strategies.

For example, a trader could have sold a call option, effectively gaining negative exposure to Bitcoin above a specific price, but unfortunately, there’s no easy way to estimate this effect.

In essence, Bitcoin bears need to push the price below $22,000 on Feb. 3 to flip the tables and secure a $165 million profit. But, for now, bulls are well positioned to profit from the BTC weekly options expiry and use the proceeds to further defend the $23,000 support.

The views, thoughts and opinions expressed here are the authors’ alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

Tether CTO denies borrowing from bankrupt lender Celsius

Celsius bankruptcy report by court-appointed examiner Shoba Pillay either has a typo, or a “mischaracterization,” Tether’s chief technology officer stated.

According to its chief technology officer, the company behind Tether (USDT), the world’s largest stablecoin by market capitalization, has never received any loan from the bankrupt cryptocurrency lender Celsius.

Paolo Ardoino, the chief technology officer at Tether and Bitfinex crypto exchange, took to Twitter on Jan. 31 to announce that Tether has “never borrowed from Celsius.”

The tweet came in response to the Celsius bankruptcy examiner report, which allegedly mistakenly implied that Tether was among Celsius’ borrowers alongside firms like Three Arrows Capital, which borrowed $75 million from the firm.

Released on Jan. 31, the examiner report mentioned on page 183 that “Celsius’s loans to Tether were twice its credit limit.”

The report notes that “Tether’s exposure eventually grew to over $2 billion,” which became an issue in late September 2021 when it was described to the risk committee as presenting an “existential risk” to Celsius.

Denying any exposure to troubled Celsius, Ardoino suggested that examiner Shoba Pillay mixed up prepositions in the examiner report, actually meaning “Celsius loans from Tether” instead of “Celsius loans to Tether.”

“Either is a typo or a mischaracterization,” Tether’s chief technology officer wrote in a Twitter thread started by Financial Times reporter Kadhim Shubber.

Shubber also mentioned that the examiner report is associated with some level of miscomprehension, stating:

“The examiner’s report above describes Celsius having ‘loans’ to Tether, but I think the exposure comes from Celsius having posted collateral in excess of the amounts it borrowed from Tether.”

As previously reported, Celsius allegedly borrowed $1 billion from Tether with Bitcoin (BTC) in 2021. Celsius founder Alex Mashinsky stated that the company was paying an interest rate of between 5% and 6%. In June 2022, Tether said it liquidated the $900 million loan, which came about a month after Celsius halted withdrawals.

Related: Celsius publishes list of users eligible to withdraw majority of assets

According to the latest examiner report, the loan amount was much larger than $1 billion. “Celsius had borrowed $1.823 billion of the stablecoin USDT from Tether, posting as collateral $2.612 billion of its assets under management,” examiner Shubber wrote, adding that the collateral amounted to 17% of all Celsius’ assets.

Apart from providing massive loans to Celsius, Tether is known as an early investor in the bankrupt firm. In 2020, Celsius secured a $10 million equity raise from Tether, with Mashinsky highlighting it as an important endorsement by the firm.

Celsius publishes list of users eligible to withdraw majority of assets

Eligible creditors will not be able to withdraw their funds from Celsius unless they update their accounts with AML and KYC data.

Bankrupt cryptocurrency lending firm Celsius had come up with a withdrawal process for users who had their crypto in its custody when it stopped withdrawals in June 2022.

Celsius released an official update on upcoming withdrawals on Jan. 31, providing the list of users eligible to withdraw approximately 94% of qualified custody assets.

The firm laid out the process in a 1,411-page court filing with the United States Bankruptcy Court for the Southern District of New York, listing the full names of all the eligible users alongside the type and amount of debted crypto assets.

Celsius stressed that eligible users would be asked to update their Celsius account with certain required information before any withdrawals are processed. The requested information includes customer data related to Anti-Money Laundering and Know Your Customer policies, as well as details about the destination address of the withdrawal, Celsius said, adding:

“Unless and until an eligible user updates his or her account with the required account updates, such eligible user will be unable to withdraw his or her distributable custody assets from the debtors’ platform.”

The filing also notes that it’s not yet known whether eligible users will be able to withdraw the remaining 6% of the assets as the court will make a decision regarding this question at a later date.

Eligible users will also receive specific details related to gas and transaction fees associated with the upcoming withdrawal procedures. “Eligible users who do not have sufficient assets in their accounts to satisfy these fees will not be permitted to withdraw their assets,” Celsius wrote.

Related: Judge denies motions from Celsius users seeking to reclaim assets

The news comes amid Celsius’s court-appointed examiner submitting a court filing on certain aspects of operations at the lender, including details about its complex dealings with the collapsed FTX exchange. The examiner report also revealed that Celsius used the accounting software Quickbooks to keep track of its finances, just like FTX and Alameda Research did.

Court-appointed examiner Shoba Pillay also wrote that Celsius and its founder Alex Mashinsky did not deliver on their promises surrounding its native Celsius (CEL) token and other business activities.

Genesis Capital’s fall might transform crypto lending — not bury it

TradFi firms with expertise in risk management may soon “fill the void” left by bankrupt crypto lenders, a Duke finance professor predicts.

Is crypto lending dead, or does it just need better execution? That’s a question asked with more urgency in the wake of Genesis Global Capital Jan. 19 bankruptcy filing. That, in turn, followed the demise of other prominent crypto lenders, including Celsius Network and Voyager Digital in July 2022, and BlockFi, which filed for Chapter 11 bankruptcy protection in late November 2022.

Unlike many traditional creditors, like banks, cryptocurrency lenders aren’t required to have capital or liquidity buffers to help them weather hard times. The collateral they hold — cryptocurrencies — typically suffer from high volatility; thus, when markets plunge, it can hit crypto lenders like an avalanche.

Edward Moya, a senior market analyst at Oanda, told Cointelegraph, “The demise of crypto lender Genesis reminded traders that there still needs to be a lot more cleaning up in the cryptoverse. You don’t need exposure to FTX to go under and that theme might continue for a while for many distressed crypto companies.”

Echoing those comments, Francesco Melpignano, CEO of Kadena Eco, a layer-1 blockchain, expects to see “contagion from these meltdowns continue to reverberate this year and maybe the next few.”

‘It’s a failure of risk management’

Is crypto lending kaputt? It’s a question Duke University finance professor Campbell Harvey was asked lately. His answer: “I don’t think so.” He believes the business model remains sound and there is a place for it in future finance.

Many traditional loans today are overcollateralized, after all. That is, the collateral provided may be worth more than the loan, which is unnecessary from a borrower’s point of view and makes for a less efficient financial system. Of course, the problem with many crypto lending transactions is the opposite — they are undercollateralized.

However, a safe middle ground could be reached if one applies professional risk management practices to crypto lending, said Harvey, co-author of the book, DeFi and the Future of Finance. 

He believes that those bankrupt crypto firms failed to plan for worst-case market scenarios and it wasn’t for lack of knowledge. “Those people knew crypto’s history,” Harvey told Cointelegraph. Bitcoin (BTC) has fallen more than 50% at least a half-dozen times in its short history and lenders should have made provisions for significant drawdowns — and then some. “It’s a failure of risk management,” said Harvey.

Crypto lending firms also failed to diversify their borrower portfolios by number and type. The idea here is that if a hedge fund like Three Arrows Capital (3AC) collapses, it shouldn’t bring down its creditors with it. Genesis Global Trading lent $2.4 billion to 3AC — far too much for a firm its size to lend to a single borrower — and presently has a claim for $1.2 billion against the now-insolvent fund.

A traditional lender typically performs due diligence on a borrower to check out its business prospects before lending it money, with collateral often adjusted based on counterparty risk. There is little evidence this was done among failed crypto lenders, however.

What could explain this disregard for basic risk management practices?  “It’s easy to start a business when prices are rising,” said Harvey. Everyone is making money. It’s simple to push worst-case-scenario planning to the side.

Recent: Inside the World Economic Forum: Circle, Ripple reflect on Davos 2023

The appeal of crypto loans in good times is that they offer individuals or businesses liquidity without having to sell their digital assets. Loans can be used for personal or business expenses without creating a tax event.

Some suggest we are now in a transitional time. Eylon Aviv, a principal at venture capital firm Collider Ventures, views cryptocurrency lending as an “essential primitive for the growth of the crypto ecosystem,” but as he further explained to Cointelegraph:

“We are currently caught in transitional limbo between centralized actors [Genesis, 3AC, Alameda Research] that have a scalable solution with poor risk management and handshake deals that go belly-up; and decentralized actors [Compound, Aave] that have a resilient but non-scalable solution.” 

Wherefore DCG?

Genesis is part of the Digital Currency Group (DCG), a venture capital company founded by Barry Silbert in 2015. It’s the closest thing that the crypto industry has to a conglomerate. Its portfolio includes Grayscale Investments, the world’s largest digital asset manager; CoinDesk, a crypto media platform; Foundry, a Bitcoin mining operation; and Luno, a London-based crypto exchange. “One big question mark on everyone’s mind is what will be DCG’s fate?” said Moya. 

Barry Silbert at a hearing before the New York State Department of Financial Services in 2014. Source: Reuters/Lucas Jackson/File Photo

If DCG were to go bankrupt, “a mass liquidation of assets could deliver a shock to crypto markets,” said Moya of Oanda. However, he believes the market may not necessarily see a return to the recent lows, even though DCG plays a big part in the crypto world. Moya added:

“Much of the bad news for the space has been priced and a DCG bankruptcy would be painful for many crypto companies, but not game over for holders of Bitcoin and Ethereum.”

“It is rumored that the [Genesis] bankruptcy was part of a plan with creditors,” Tegan Kline, co-founder and chief business officer at software development firm Edge and Node, told Cointelegraph. Whether or not that is the case, “the filing means that DCG and Genesis are unlikely to dump coins on the market and this is one of the reasons that recent [market] price action has been positive,” said Kline.

Kline thinks DCG may have sufficient resources to weather the storm. It depends “on how well DCG can ring-fence itself from Genesis,” Kline added. “DCG has a valuable venture portfolio. On that basis alone, my bet is that it is likely to survive either by raising external capital or giving some equity over to creditors.”

A new wave of lenders

DCG aside, the crypto lending sector can probably expect some changes before the end of 2023. Harvey anticipates a new wave of crypto lenders emerging, spearheaded by traditional finance (TradFi) firms, including banks, to replace the now depleted ranks of crypto lenders. “Traditional firms with expertise in risk management will enter the space and fill the void,” Harvey predicted. 

These banks are now saying to themselves something along the lines of, “We have expertise in risk management. These lenders got cratered and there’s now an opportunity to go in and do it the right way,” Harvey said.

“I completely agree,” added Collider Venture’s Aviv, who believes TradFi may soon be rushing in. “The competition is well on its way for the highly lucrative lending market.” The main players will be centralized entities like banks and financial firms, but Aviv expects to see more players with decentralized protocols built on top of Ethereum and other blockchains. “The winners will be the consumers and users, who are going to receive better, cheaper and more reliable services.”

Shawn Owen, the interim CEO of SALT Lending, told Cointelegraph, “The emergence of traditional financial firms in the crypto lending market is a development we saw coming, and it showcases the growing mainstream acceptance and potential of this innovative industry.”

Few emerge unscathed

SALT Lending built one of the earliest centralized platforms to allow borrowers to use crypto assets as collateral for fiat loans. It has registered with the United States Financial Crimes Enforcement Network and has a history of third-party audits. While it doesn’t conduct credit checks on borrowers, it performs full Anti-Money Laundering and Know Your Customer verification, among other screenings. Still, SALT Lending hasn’t come out unscathed from the recent turmoil. 

The firm froze withdrawals and deposits to its platform in mid-November 2022 because “the collapse of FTX has impacted our business,” it said. Around this time, crypto securities firm BnkToTheFuture announced that it was ending its efforts to acquire its parent, SALT Blockchain. SALT Lending’s consumer lending license was recently suspended in California too.

The “pause” on withdrawals and deposits, as the company calls it, was still in effect early this week. However, a Salt Lending source told Cointelegraph that: “We’re in the final stages of going through an out-of-court restructuring that will allow us to continue normal business operations. We’ll have an official statement about this very soon.”

Still, amid all the upheaval, Owen insists that with proper management, the practice of lending and borrowing crypto assets “can be a valuable tool for achieving financial growth and stability.”

More regulation coming?

Looking ahead, Owen expects more regulation of the cryptocurrency lending sector, including measures “such as the implementation of capital and liquidity buffers, similar to those required of traditional banks,” he told Cointelegraph.

Some practices like rehypothecation, where a lender re-uses collateral to secure other loans, may come in for closer scrutiny. Owen also expects to see more interest in “cold storage” lending, “where borrowers are able to monitor their funds throughout the duration of their loan.”

Others agree that regulation will be on the table. “DCG’s debacle has [had] an incredibly detrimental effect on institutional investors, which also means that retail investors will feel the brunt of it,” Melpignano of Kadena Eco told Cointelegraph. “I would liken it to a one-two punch that will give regulators the ammunition they need to move aggressively against the industry.” He added:

“The bright side is the industry finally has a catalyst for clear regulations to enter the space — entrepreneurs will need regulatory clarity both to build the use cases of tomorrow and attract institutional investment.”

‘A poisonous drug’

Maybe it’s premature to ask, but what lessons have been learned from the Jan. 19 bankruptcy filing? The Genesis bankruptcy “reinforces the narrative that crypto lending should happen in a transparent manner on-chain,” Melpignano said. “For as dire as the situation may be for the industry in the short-run, on-chain lending protocols were unaffected by all of 2022’s unfortunate events.” In his view, this solidifies the use case for decentralized finance — a more transparent and accessible financial system.

“If there is a core lesson to learn from last year, it is not to idolize and trust ‘thought leaders’ and ‘talking heads,’” said Aviv. The industry has to push for “maximum transparency and audibility.”

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“High leverage is the most poisonous drug in finance, not only in crypto,” Youwei Yang, chief economist at crypto miner Bit Mining, told Cointelegraph. This is probably the most important lesson to be drawn, but the need for better risk management protocols is also now clear. People have learned that “loosening the standards during hyped [up] market conditions can be a disaster after the liquidity pulls out,” Yang added.

Stronger and ‘better prepared’

Aviv says crypto lending will survive the crypto winter “and come out stronger through the other side” by using on-chain assets “that enforce and simplify both audibility and regulation.” He expects continued innovation in this space, including “new forms of collateral like real-world assets, transparent custodians and enforceability via new account abstraction primitives.”

Overall, cryptocurrency lending remains a useful financial innovation, but its practitioners need to embrace some of the state-of-the-art risk management practices developed by traditional finance firms. “The idea is good, but the execution was a failure,” summarized Duke University’s Harvey. “The second wave will be better prepared.”