Author:Chloe
Celsius Network, the world's largest cryptocurrency lending platform, has been accused of fraud by its former investment manager.
The plaintiff Jason Stone tweeted on July 8 that Celsius maliciously used customer deposits to manipulate the price of its own cryptocurrency, resulting in the freezing of customer assets. However, Celsius refused to admit its mistakes, nor did it admit its own negligence in risk management and other aspects, and even tried to shift the responsibility to Jason Stone. Therefore, Jason Stone decided to take legal action and sue Celsius.
Jason Stone said that the investment company "KeyFi" he founded was partially acquired by Celsius in 2020. Since then, he has worked for Celsius for a long time, focusing on staking business and deploying DeFi strategies.
Celsius created the whale address "0xb1" in August 2020, transferred customer deposits to the address for investment, and then handed it over to Jason Stone to take the lead in management, and both parties shared the private key. To this end, KeyFi also signed a customer fund management agreement with Celsius and jointly established a new company called "Celsius KeyFi".
“Because its business model depends on providing depositors with more money than they put in, Celsius must continually take in new capital to pay its obligations to existing depositors,” Jason Stone wrote in the complaint. “In other words, Celsius is a Ponzi scheme.”
After realizing the problems, Jason Stone decided to resign in March 2021, but Celsius has so far refused to pay them their share of the profits.
"Given public speculation about the company's solvency and my observation that Celsius had a loose relationship with the truth, I have initiated legal action against Celsius to resolve this long-standing issue," he said.
Crypto asset lending platform Celsius becomes the shadow of traditional banks
First, Celsius is a crypto asset lending platform that facilitates loans for various crypto assets. The company's business model is similar to that of a deposit lender, accepting monetary deposits from consumers and then using those funds to provide liquidity to the market through loans and investments. Instead of fiat currency, depositors hand over crypto assets to Celsius.
Simply put, Celsius is like a bank, helping these consumers earn a return on their investment funds, paying them the interest they earn, and keeping the profit. Most importantly, if Celsius cannot invest depositors' funds in investments that earn more than the interest owed, depositors will face losses.
Celsius is like copying a traditional bank, but their terms of service try to protect the company from the same liabilities that old banks have.
For example, the terms of service state that any funds do not need to be held in a customer's account to be book property, so Celsius can use these assets as it pleases.
And unlike traditional depository institutions, Celsius does not insure itself against any loss of customer funds, and they do not guarantee any legal means for their customers' funds. They do not even provide loans to consumers based on credit, but only to retail borrowers who deposit crypto assets as collateral.
Like many other crypto asset businesses, Celsius issued its own crypto asset in March 2018, called "CEL". Celsius promotes the use of its CEL token by offering customers the option to receive interest payments from Celsius in the form of CEL tokens at a higher rate than Celsius would otherwise pay for deposits. Likewise, customers who use CEL to repay their loans are charged a lower interest rate.
Finally, all of Celsius’ balance sheets are based on USD for business operations. Therefore, if the price of CEL tokens increases, Celsius can pay customers less CEL tokens as interest, and the amount of deposits Celsius holds for its customers is highly variable due to the growing demand for crypto lending platforms.
Despite the staggering amount of customer deposits, Celsius and its management had little experience in trading and investing in crypto assets.
In the summer of 2020, due to DeFi innovation and many novel concepts, many new types of financial management concepts were derived. Celsius tried to participate in DeFi, but the team lacked expertise. Therefore, Celsius tried to hire an expert to handle customer funds for deployment in DeFi protocols.
Looking for DeFi cooperation opportunities, KeyFi becomes the team's first choice
In the summer of 2020, Celsius found a crypto asset trading team to cooperate with, namely Jason Stone, the founder and CEO of KeyFi. At that time, KeyFi was a highly technical company focusing on DeFi deployment and strategy, and it had achieved great success. It happened that the founder of Celsius and Stone knew each other, so Celsius and KeyFi reached a cooperation agreement, and KeyFi would manage billions of dollars of crypto deposits from Celsius customers.
On August 19, 2020, without reaching a formal agreement, Celsius began transferring hundreds of millions of dollars in crypto assets to Stone and his team, who created a new Ethereum wallet address called the "0xb1" account. Since then, almost all assets transferred by Celsius have been deployed to this address by Stone, and Celsius has full control over the 0xb1 account.
During the time they worked together, Stone could only access the 0xb1 account by logging into 0xb1 using a VPN, a computer account controlled by Celsius. But not long after, Celsius provided Stone with direct access to the 0xb1 account. The reason for this was that the service provider GoDaddy.com was hit by a "DNS attack" by hackers. Fearing that hackers could completely hijack all of Celsius' network traffic, in order to protect the 0xb1 account, Celsius provided Stone with the private key of the 0xb1 account so that he could access the account smoothly without using a VPN.
The two parties have yet to sign a formal contract and are only using trust as a trading strategy?
Although the cooperation between the two parties has become: both parties intend to share the profits generated by the huge assets, there is no formal written agreement between the two parties. In other words, no matter how much money Celsius transfers to Stone and entrusts Stone and his team to invest, all this is based on a handshake agreement between the two parties.
In addition, Celsius transferred crypto assets to Stone for investment and also conducted certain transactions in the name of Stone, but did not transfer the assets to Stone for control. The two parties only agreed to record the gains and losses of such transactions in KeyFi's income statement to facilitate profit allocation.
This also reflects the relationship between the two: the two sides are interdependent, and funds bring mutual benefit to both sides.
It wasn’t until October 2020 that Celsius and Stone decided to execute the risk management and hedging required for certain DeFi transactions to protect against movements in crypto assets caused by rising token prices.
At that time, Celsius’ management told Stone that it would monitor Stone’s DeFi activities and deploy certain hedging strategies that could guard against prices. The main reason was that Stone’s DeFi strategy was based on Ethereum, which was to deposit a large amount of ETH and invest it in DeFi projects with possible returns to obtain non-ETH-denominated assets.
Just after Celsius and KeyFi had jointly managed user funds for more than a month, KeyFi signed an agreement "MOU" in which KeyFi would provide DeFi strategies and its employees with special access to Celsius. Prior to signing the agreement, Celsius had transferred hundreds of millions of dollars to Stone and his team without any formal written agreement.
So what happened was that KeyFi agreed to commit all of its resources, all of its crypto assets, to manage Celsius’ investments, all without any formal agreement protecting it, and of course, all of this was done on the basis that KeyFi believed that its partner Celsius would operate in good faith.
It was not until the end of 2020 that the two parties executed the first contract signing agreement
Given Stone’s past success in managing Celsius, Celsius was clearly very satisfied with Stone, so they decided to continue sending funds to Stone for weekly deployment, and the agreement was formally signed. Around December 31, 2020, a series of two contracts drafted by Celsius formalized the cooperation between KeyFi and Celsius: the Asset Purchase Agreement (APA) and the Service Agreement.
Celsius violated the APA and Service Agreement by refusing to provide KeyFi with an accounting and payment for such fees until January 2021. KeyFi was alarmed by Celsius’s improper business practices both before and after the signing of the APA and Service Agreement, and ultimately concluded that Celsius’ internal business practices were so corrupt that he and KeyFi could no longer do business with Celsius.
First, KeyFi became aware that Celsius had conducted a series of transactions since February 2020 that artificially inflated the price of the CEL token.
At the time, Connor Nolan, head of token deployment at Celsius, informed KeyFi that Celsius used approximately 4,500 bitcoins (now worth $90 million at the time) as customer deposits on the open market to purchase CEL to drive up prices between February and November 2020.
Not only that, Celsius induced customers to pay in CEL tokens by offering them higher interest rates, and then artificially raised the price of CEL tokens so that Celsius was able to pay customers who chose to receive interest in the form of CEL tokens, or even smaller amounts of crypto assets.
Furthermore, by artificially inflating the price of CEL tokens, Mashinsky personally owned hundreds of millions of dollars worth of CEL tokens at the peak of the CEL token’s value.
Essentially, Celsius was completely manipulating the CEL token market in order to borrow from its massive treasury to create a situation where it was ostensibly generating revenue but was actually owing customers money.
As a result, Stone realized that Celsius was a scam, and Celsius failed to implement the promised hedging transactions, which also harmed Stone and KeyFi. Celsius failed to properly hedge all its profitable activities, exposing other customer deposits to billions of dollars in unrealized losses. Internal financial mismanagement also threatens to put the company into bankruptcy.
Even though Celsius paid some interest on CEL token deposits, as well as some interest on other crypto assets like Bitcoin and Ethereum, for consumers who chose to deposit crypto assets instead of CEL tokens, Celsius only paid these customers in tokens. Then as the crypto assets appreciated in value, it failed to mark these assets to market in its internal ledger, creating a huge hole in its company’s finances.
The bull market is coming! The tide is receding, and Celsius's vision is gradually fading?
Celsius failed to update its distributed ledger until crypto assets like Bitcoin and Ethereum appreciated significantly against the U.S. dollar between 2020 and 2021, and the company’s finances concealed hundreds of millions of dollars in liabilities that Celsius refused to pay.
By the time Jason Stone left Celsius, there was a $200 million hole on Celsius' balance sheet, and Celsius was unable to give any explanation or solution. Although the balance sheet continued to show signs of bankruptcy, Celsius still intended to assume more of its customers' assets, which meant that Celsius had no intention of stopping and only wanted to continue accumulating large amounts of debt, harming the interests of all creditors.
In January 2021, the crypto market began a bull cycle, causing Celsius to face severe exchange rate losses. When customers tried to withdraw ETH deposits, Celsius was forced to purchase ETH on the open market at its historical highest price, suffering huge losses.
Faced with a liquidity crisis, Celsius began offering double-digit interest rates to attract new depositors, whose funds were used to repay earlier depositors and creditors. Therefore, although Celsius continued to package itself as a transparent and well-capitalized enterprise, it had actually become a Ponzi scheme.
It was not until March 2021 that it became clear to KeyFi that Celsius’ Ponzi scheme could cause huge financial losses to Celsius and its consumers, which could also cause irreparable damage to KeyFi’s reputation. Celsius had already missed the first payment to KeyFi in December 2020, and although Stone had been authorized to purchase NFTs as an advance payment for the profit share under the Agreement, APA, and Service Agreement, Celsius failed to provide a specific description of the total profit share.
Celsius and KeyFi officially declared defeat
On March 9, 2021, Celsius notified Stone that he would no longer serve as CEO of Celsius KeyFi, and after Stone left Celsius KeyFi, Celsius continued to access and control the 0xb1 wallet. Celsius CEO Alex Mashinsky used this control for his own personal benefit, namely transferring valuable non-financial assets from the 0xb1 account to his wife's wallet.
Since its business model depends on giving depositors more money than they put in, Celsius must constantly take in new capital. For example, to pay off its growing debt, Celsius was required to borrow about $1 billion from Tether. Although Celsius paid 5%-6% interest on the $1 billion loan, the amount it owed to its customers continued to grow because it had previously accepted many popular tokens as deposits.
Tether loans, along with other Celsius deposits, are used to mask Celsius’s numbers on its balance sheet. Even so, Celsius continues to promote its high-interest deposits to entice new depositors to provide it with more funds to repay earlier depositors.
On June 12, 2022, Celsius announced that it had suspended withdrawals and transfers between all accounts due to extreme market conditions. This drastic action was taken because the company no longer had any crypto assets on hand to fulfill its debts to customers.
Celsius’ previous claim that it “had sufficient reserves to meet its obligations under our comprehensive liquidity risk management framework” has now been shattered.
As of May this year, customer deposits were worth about $11.8 billion. According to reports, Goldman Sachs is seeking to acquire Celsius' assets for a bargain price of $2 billion.
Jason Stone stated, “Celsius assured me that their trading team fully hedged any potential impermanent losses caused by our activities in the liquidity pool. They also assured me that they conducted risk management and hedging to cope with fluctuations in token prices, but in late February 2021, we discovered that Celsius had deceived us. They did not hedge our activities or hedge against fluctuations in crypto asset prices.”
For now, Celsius' balance sheet remains a black box.
Nexo, a crypto lending platform, tweeted that it could acquire any remaining eligible assets of Celsius at any time, but Celsius did not respond. Some people also pinned their hopes on Tether, an early investor in Celsius, but Tether seemed to just want to distance itself from the issue, saying that "Celsius' financial crisis has nothing to do with Tether and will not affect its USDT."
In an era of rampant liquidity, many companies use high yields as bait, frantically marketing to attract money to expand their liabilities. However, when the lending business cannot meet the needs of the huge amount of deposited funds, they begin to invest frantically overseas, in real estate, listed company debt, VC LP, and history will always be surprisingly similar.
In every bull-bear cycle, there will always be people who experience the pain of deleveraging, and there will always be people or institutions that become the "price" to be sacrificed. After LUNA's stable DeFi vision was shattered, CeFi also ushered in a moment of disillusionment. Founder Mashinsky had to bow his head and admit defeat to the market. Where will he go in the future?