Celsius Network Scam: A Technical Ponzi Scheme

Published connected January 18th, 2022

In this article, I proceed my reappraisal of replacement finance platforms that person been proliferating because pinch liking rates debased for truthful long, group person been hopeless for finance returns. For galore years, savings accounts offered 0% rates, truthful savers and investors were incentivized to return larger risks for nan replacement finance platforms advertizing 8-10% rates.

If you’ve been progressive pinch crypto you’ve astir apt encountered nan fistful of Centralized Finance (CeFi) platforms for illustration nan Celsius Network. In this article I springiness an honorable reappraisal of nan level and constituent retired a assortment of reddish flags. I wanted to for illustration them for those juicy 8.5% yields, but location are conscionable too galore issues for maine to consequence superior connected this platform.

April 13 Update:
USA users will nary longer gain liking connected recently deposited costs astatine Celsius unless they are accredited investors aft respective authorities lawsuits. This follows nan SEC enforcement and $100 cardinal punishment applied to BlockFi which antecedently offered nan aforesaid merchandise (Nexo stopped offering their crypto gain merchandise to USA users connected nan aforesaid time arsenic BlockFi).

Furthermore, location are immoderate unsocial risks and imaginable reddish flags that we will talk that unit investors mightiness not beryllium getting compensated for erstwhile placing their cryptocurrency assets onto this platform.

What is Celsius Network?

As cryptocurrency has expanded successful usage complete nan past fewer years, plentifulness of group person purchased Bitcoin, Ethereum and different coins and person conscionable near them sitting successful a wallet for years waiting for them to admit arsenic portion of their finance portfolio. It tin sometimes beryllium a very agelong hold erstwhile a cryptocurrency carnivore marketplace hits and lasts for respective years.

It’s dormant money conscionable sitting around.

Celsius and a fewer others including Nexo and BlockFI realized that each these superior assets are conscionable locked distant and not doing thing productive and came up pinch nan thought of a marketplace for lenders and borrowers, akin to a bank. Depositors tin move their cryptocurrency into a output base assets and borrowers tin person immoderate of their gains into usable rate without incurring a taxable liability.

The Celsius Network level besides provides nan opportunity to lever up a position aliases short a position, truthful successful a batch of ways they make markets much complete arsenic they unlock superior and fulfill various needs that were not imaginable before.

Overall I deliberation these kinds of businesses are bully for cryptocurrency adoption, if they don’t implode eventually, that is.

How Celsius Reportedly Makes Its Money

The absorbing point astir Celsius is that successful nan US, they are a private, unregulated finance business, not taxable to nan aforesaid rules that would use usually to a emblematic bank, finance manager, aliases publically traded company. This position offers Celsius nan opportunity to prosecute successful a batch of replacement cryptocurrency investments free from regulatory restrictions that would measurement down emblematic fiduciary finance managers.

They are capable to get astir nan emblematic banking and money head rules because they do not woody pinch USD fiat; their business is strictly cryptocurrency only, which nan IRS has ruled to beryllium property, truthful moreover USD stablecoins don’t suffice arsenic money. This is was fundamentally a loophole for a patient for illustration Celsius to get astir accredited investor status, which excludes astir of nan state from participating. After nan authorities lawsuits mentioned astatine apical of this article, their lend merchandise is now only disposable to accredited investors, but it took a fewer years.

Celsius does not only link depositors and borrowers and supply an avenue for investors to lever up and short, they efficaciously run for illustration a backstage equity business pinch a fistful of replacement cryptocurrency investments.

For instance, they precocious purchased a cryptocurrency farm, they liking nodes connected Proof-of-Stake chains, supply money to DAOs, supply short trading inventory to hedge costs aliases exchanges, and they waste and acquisition astir their civilization CEL token. Their business has a batch of imaginable gross streams that are overmuch different than emblematic finance managers are capable to return advantage of.

For an individual investor incapable to prosecute successful nan aforesaid gross streams connected their own, it’s a measurement to prosecute a head to diversify one’s portfolio. But you person to beryllium observant because their finance portfolio is opaque and you don’t person a granular penetration into what they put into aliases own.

The interest is that they are conscionable doing nan aforesaid DeFi strategies that you are already doing connected your own. For instance, it came retired that Celsius had invested $500 cardinal into nan Anchor Protocol that precocious failed. They reported they sewage retired early truthful it sounds for illustration they didn’t return overmuch of a hit, but if you besides invested money connected your ain into nan Anchor Protocol, you unknowingly risked much superior to nan level than you thought.

Celsius is Currently Operating arsenic a Technical Ponzi Scheme

Unfortunately, nan revenues are not presently sustaining nan business. When I first started looking into nan company, I was very intrigued by nan pursuing connection because I person looked astatine nan financials for hundreds of companies:

Celsius returns up to 80% of what we gain (and that’s earlier we deduct immoderate expenses)

Source

That condemnation belies nan truth that they are paying retired 80% of revenues, not earnings. Very fewer tech based companies person profit margins moreover northbound of 40%, truthful that was instantly clear to maine that their operations are not self-sustaining and they were paying retired much liking to investors than they were generating from business operations. If payments are not coming from revenues, it tin only travel from 1 different place, different investors. That is simply a method qualification of a Ponzi scheme. In a pursuing conception we break down immoderate financial reports showing their income and losses.  

Now, it is clear that they want to turn into a self-sustaining cryptocurrency investor business by creating income streams successful various cryptocurrency arenas, but that still doesn’t absolve them from nan truth that existent investor returns are not sustainable. Do you wonderment why they support reducing nan liking complaint they salary complete time? Well because they person to pull much investor money to salary nan precocious rates and location is simply a limit to really accelerated nan level tin pull caller money, particularly arsenic crypto take began to slow towards nan extremity of 2021.

This is simply a unsocial business because if they didn’t person crypto investors hoarding their money connected nan level to turn their business, they would person to rumor indebtedness junk bonds pinch pesky paperwork, recourse and stipulations. I show beneath that erstwhile you spot your money onto nan Celsius Network, it becomes their property.

Ask yourself if a regulated fiat money business would beryllium allowed to Ponzi-out for a while until their revenues caught up pinch nan returns they were paying. Most surely not. Unfortunately astir Celsius investors are apt not alert that their returns are coming from different investors and location mightiness not beryllium capable superior to spell astir to fulfill each withdrawal requests if a ample percent of investors wanted retired astatine nan aforesaid time.

Several states including Texas and New Jersey person issued cease-and-desist notices to Celsius and akin businesses from operating successful their territories.

On 1 manus you tin construe nan optics arsenic a classical tech startup that burns done billions of dollars to grow. On nan different hand, since they are taking investor money and paying retired much than they are earning it’s a Ponzi strategy for nan clip being. Take your prime of really you consciousness astir it.

Venture Capital Investments

You mightiness wonderment why a large finance manager and different task capitalists would put into Celsius if they are presently paying retired to investors much than they are earning. It’s because Celsius is being treated for illustration a startup that loses money for a number of years until it 1 time becomes profitable. They are besides apt betting it’s nan adjacent Lending Club type level pinch greater fools fresh to return nan IPO disconnected their hands.

However, there’s batch of irony present because Celsius successful 2019 published a now deleted blog post criticizing a competitor for utilizing VC costs to subsidize investor returns erstwhile they do nan aforesaid thing.

2020 Financials (Nerd Zone)

You tin safely skip this conception if your eyes glaze complete while reference operating reports.

The financials travel from nan UK wherever they besides operate. Unfortunately location is simply a immense lag from nan play erstwhile they people nan reported period, truthful we only person accusation up until Dec 2020 which leaves retired immoderate of their caller developments for illustration nan cryptocurrency mining workplace they conscionable purchased. The financial reports besides aren’t arsenic elaborate arsenic nan reports you will find successful nan US. Furthermore, they are scanned pinch horrible formatting making them difficult to read.

However, we tin summation immoderate insights from looking astatine them. At nan extremity of 2020 they had 2 superior gross streams:

1) lending of securities to exchanges, which is fundamentally supplying liquidity to exchanges and

2) organization lending, which mightiness dwell of institutions getting leveraged aliases short exposure.

Retail lending is simply a pittance of their income truthful nan antiauthoritarian “borrow for illustration a billionaire” Pizza HODL statement doesn’t look to clasp overmuch h2o connected their platform.  All successful all, they made $51 cardinal successful gross successful 2020.

I could not find a breakdown of gross paid to investors. Cost of income is only half though, truthful it doesn’t lucifer up to nan advertised 80% figure. Cost of income could beryllium different things for illustration marketing, aliases referral signup bonuses.

After you region nan costs of income and nan costs to tally nan business, nan extremity consequence was an operating nonaccomplishment of almost $5 million, if we disregard 2 ample competing forces of unrealized nonaccomplishment connected cryptocurrency successful their possession and mark-to-market gains of their CEL treasury tokens which led to a GAAP (presumably) nonaccomplishment of $1.4 cardinal for nan year.

One of nan overseas things to maine from nan income connection was nan $2.2 cardinal successful unrealized losses from cryptocurrency connected their equilibrium sheet. 2020 was an up twelvemonth for Bitcoin and Ethereum, which are presumably nan astir plentiful assets stored connected their platform, speech from stablecoins. They don’t break retired nan distribution of their cryptocurrency inventory, but really did nan depositors person specified ample unrealized losses? It’s a small weird.

Also absorbing to maine was moreover pinch nan $3.5 cardinal summation successful customer deposits, nan rate travel from operations was only $17 million.

I very overmuch look guardant to updating this article erstwhile nan latest numbers are published for 2021, expected successful a fewer months.

The CEL token

As portion of their original whitepaper they fed group a statement of BS astir nan necessity of it:

Our lending and borrowing exemplary requires a blockchain and an unfastened ledger technology, it besides requires statement and a world footprint of coin holders successful bid to really summation traction and complete our mission. Any indebtedness we rumor whitethorn beryllium collected from thousands of individual coin holders which whitethorn beryllium switched astatine immoderate time. Only a smart statement tin of search and paying successful micropayments tin grip specified complexity.

The point is, they don’t person a blockchain and CEL is only a elemental inferior token pinch standard functions connected nan Ethereum network. Managing a indebtedness ownership floor plan does not require a blockchain. A elemental database for a centralized authority for illustration Celsius does nan occupation quicker and cheaper than a blockchain can.

The existent intent of this token was to create an ICO that netted them $50 cardinal without strings to commencement financing their operations. But location is 1 different valuable feature: they tin salary investors pinch this token they minted retired of bladed aerial because non-US investors person nan action to person their returns successful nan CEL token for an other 2% output and it costs Celsius efficaciously nothing.

As such, this token really serves nary intent for investors. If you clasp CEL aliases return net successful CEL, it’s connected you to nonstop it to an speech and get a favorable conversion to nan cryptocurrency of your choice. You are taking marketplace consequence that its worth will drop, which reduces your effective output bonus, and speech complaint slippage risk. Additionally, if Celsius arsenic a business goes under, CEL tokens will illness successful worth since location will beryllium nary marketplace for them.

The worst portion of nan CEL ICO is that it didn’t springiness you ownership liking successful nan Celsius business. It’s not for illustration a stock of banal pinch an equity claim. All nan equity claims connected their business are accruing to nan task capitalists who will get a large payday erstwhile they IPO.

They do get an A for transparency for which wallets they power that incorporate CEL pinch nonstop links to Etherscan though.

Additional Risk of nan Celsius Platform

Company Leadership Scandals

I looked into nan past of nan CEO Alex Mashinsky. The number of patents and his position arsenic nan “inventor of VoIP” seems to beryllium embellished successful overmuch of their trading materials, but wide he seems to beryllium a reputable businessman pinch entrepreneurial accomplishments done a fewer companies, truthful thing really stood retired arsenic being a reddish flag.

The aforesaid cannot beryllium said for immoderate precocious level institution officials though. About nan worst point you tin deliberation of happening erstwhile placing money into a institution managing your finances is nan Chief Financial Officer getting arrested for a fraud for a pyramid scheme.

Furthermore, erstwhile an early advisor to your patient was arrested for a massive fraud involving cryptocurrencies, that’s a definite concern! 

But that’s not each folks.

As a registered money work business that requires rigorous anti-money laundering checks, uncovering retired your Chief Revenue Officer established a broadside business with a convicted money launderer is not a awesome look.

This is simply a batch of fume coming from nan activity of 1 company, particularly erstwhile cryptocurrency frauds were involved.

Not Your Keys….

Celsius states successful their terms that they enactment arsenic neither a custodian aliases fiduciary and “ALL DIGITAL ASSETS TRANSFERRED TO CELSIUS AS PART OF THE SERVICES ARE OWNED AND HELD BY CELSIUS FOR ITS OWN ACCOUNT.” So erstwhile you deposit your cryptocurrency to Celsius, it becomes their spot to do pinch arsenic they please and you go an unsecured liability connected their equilibrium sheet. Not your keys, not your crypto… to nan max!

You whitethorn deliberation that they are conscionable pushing retired modular ineligible jargon, but if you put money connected a brokerage relationship and nan brokerage fails, you are covered by SIPC insurance.

They Self Insure

In 2021, Mashinsky announced that they are launching a self insurance scheme for all.

Another building for “Self Insured” is… “Not Insured.”

Celsius precocious fell unfortunate to an utilization connected nan BadgerDAO and lost $54 million successful funds. They announced that they would eat nan costs and that nary customer costs would beryllium lost, which is simply a bully thing, but what happens nan adjacent clip erstwhile it’s 10 times arsenic ample of a loss? Cryptocurrency hacks hap ALL THE TIME, pinch nan latest hack stealing $600,000,000 (later returned).

Centralized platforms are complete honeypots for hackers and person shown to beryllium risky places for investors to support their crypto holdings clip and clip again.

Rehypothecation

Inside their position of use, they authorities that they tin “pledge, re-pledge, hypothecate, rehypothecate” nan collateral you deposit connected their platform.

You mightiness deliberation that if you deposit immoderate BTC and return retired 50% of nan worth arsenic USDC stablecoin, your BTC will conscionable beryllium location locked distant waiting for you to travel backmost and salary disconnected your indebtedness since you person already borrowed against its value. But that’s not what happens. Celsius will past “double dip” and lend retired that aforesaid BTC you deposited and borrowed from pinch different loan, perchance to an speech aliases organization investor to short.

Now image that erstwhile you borrowed, you chose not to get stablecoin to retreat from nan level but alternatively decided to get further BTC to lever up your position and time off successful connected Celsius. You could beryllium successful truth borrowing from yourself pinch rehypothecation and there’s conscionable a database markup for your relationship balance. By leaving assets connected their platform, Celsius has nan expertise to enactment arsenic a fractional reserve slope and lever up aggregate times done their expertise to rehypothecate again and again, successful principle expanding nan money proviso of cryptocurrencies.

This is of people risky, because nan cryptocurrency marketplace is ripe pinch volatility and rehypothecation tin create a concatenation of cascading liquidations of collateral.

How galore times do they do this? We don’t cognize and we person nary thought what consequence guidance protocols they person successful place. As an unregulated entity, they person a batch of leeway. Prime Trust was worried capable to sever ties pinch them successful 2021 owed to this believe and an insider stated that they do it “endlessly,” which doesn’t animate confidence.

Many of you are astir apt aged capable to retrieve nan marketplace turmoil from nan Great Financial Crisis of 2007. One of biggest factors of this calamity was nan usage of rehypothecation and pledging collateral that was already spoken for again and again. In that case, nan collateral was highly illiquid existent property that would person to beryllium occurrence sold to get rate quickly and led to nan lodging marketplace meltdown arsenic proviso overwhelmed demand. Cryptocurrency is fundamentally a financial merchandise that tin beryllium liquidated quickly, but ample liquidations tin overwhelm nan demand, causing nan value to plummet, which leads to a further cascade of liquidations and yet a decease spiral.

Where Rehypothecation Can Go Wrong With Crypto

Opaque Risk Profile

Say a hedge money wants to lever up their 10,000 ETH position, presently priced astatine opportunity $3,000 per ETH. They get nan max $15 cardinal and bargain 5,000 much ETH and support it connected nan platform. Celsius is earning opportunity 10% connected nan $15,000,000. They could conscionable extremity location and clasp custody connected nan ETH for nan 10% liking but alternatively they determine to rehypothecate nan collateral and deposit it connected AAVE and gain 4% connected nan full 15,000 ETH. The hedge money is nary wiser astir wherever their collateral is at.

The indebtedness looks for illustration a debased consequence indebtedness to nan hedge money pinch nan only consequence being a devaluation of ETH, because they are only borrowing against themselves.

Then opportunity AAVE gets hacked and nan full equilibrium of Celsius ETH portfolio is stolen. Now nan existent consequence floor plan becomes evident and not only did they person to interest astir devaluation of ETH, and nan information of Celsius, but they besides had to interest astir nan information of a 3rd party’s possession.

And that is only 1 loop of rehypothecation. What if aggregate clients are each borrowing disconnected nan aforesaid plus and nan collateral is unavailable?

Bank Run

Since they person precocious purchased a mining farm, opportunity it becomes really successful and they commencement to put heavy into it. They return different large chunk of their USDC deposits, person it to USD fiat and bargain a mining farm. The mining workplace instrumentality is now a very illiquid asset.

The Fed raises rates, nan financial assets including nan banal marketplace and cryptocurrency markets tank, and group panic and withdrawal their stablecoins en masse to bargain nan dip aliases screen their surviving expenses. This script exposes nan imaginable for a “bank run” connected Celsius pinch them not capable to meet nan demands of depositors. And Celsius is not FDIC insured.

Is Celsius a Good Investment? Should You Invest successful Celsius?

While Celsius whitethorn connote they enactment for illustration a bank, they prosecute successful a batch of replacement finance businesses successful nan cryptocurrency abstraction that accepted plus managers tin not presently get progressive successful owed to regulations. This lends credence to a small spot of portfolio diversification, but nan cryptocurrency world is still for illustration nan chaotic westbound pinch its ain unsocial risks. You tin prosecute pinch galore of nan aforesaid cryptocurrency strategies that Celsius is engaging successful connected your own, but without nan centralized consequence of your assets.

While Celsius does make revenues from investing successful a assortment of cryptocurrency avenues, and they person immoderate caller ventures coming down nan line, nan latest financial accusation shows they are operating astatine a nonaccomplishment and customer returns are being paid from caller investors. That is nan meaning of a Ponzi scheme. They might grow retired of nan deficiency successful nan early from their existent investments, but they could besides neglect astatine immoderate constituent because excessively galore group want their money backmost and they can’t meet redemptions. (July 2022: I called that one, eh?)

You really person to wonderment if nan 4%-8% return connected your plus is worthy nan consequence you are taking by placing it connected their platform, erstwhile you tin put it onto a DeFi level yourself without a middleman. When you deposit your cryptocurrency onto nan Celsius level it becomes their property, taxable to hacks aliases mismanagement.

I look astatine it for illustration this: How galore years do I person to spot my plus onto nan level to double my money and what is nan consequence that nan finance mightiness spell to zero complete that clip frame? For a compounded return of 4%, it takes 18 years to double. With an 8% APY, it takes 9 years to double. That’s a agelong clip to spot your plus connected a level wherever you aren’t insured from loss.

I would opportunity the risk-reward does not balance and furthermore, you are centralizing your decentralized assets, which is simply a contradiction of nan constituent of trustless assets successful nan first place. In each reality you should shop your cryptocurrency assets (keys) connected a hardware wallet for maximum information and investigation immoderate DeFi lending platforms if you want to adhd immoderate other consequence and return.

I tin only presume that BlockFi and Nexo operate nan aforesaid way, but without immoderate publically disclosed financial documents to spell connected astatine all, it’s conscionable a conjecture (a scholar did stock that Nexo has real-time independent accountant reports showing they exceed 100% of customer liabilities, which is decidedly a favorable portion of accusation and thing that nan others CeFi platforms haven’t revealed).

I would propose that if you are comfortable pinch these kinds of investments that you divided your finance superior crossed each 3 platforms to trim nan consequence of an implosion by 1 of them. At slightest you tin diversify your consequence floor plan a small bit, but again, they are astir apt each doing nan aforesaid things down nan scenes anyway.

Come subordinate nan telegram chatroom for immoderate much investing discussion.