"Someone is lying, either the bank or Celsius."
Four major U.S. law enforcement agencies file lawsuits against Celsius and its CEO
Alex Mashinsky, the former CEO of Celsius Network Ltd., a once-operating cryptocurrency lending company, has been accused of fraud and faces prosecution by three regulators in connection with the company’s collapse.
Mashinsky, 57, was charged in federal court in New York with attempting to manipulate the cryptocurrency market. The Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Federal Trade Commission (FTC) also filed lawsuits against Mashinsky and Celsius Network.
The DOJ’s press release, Celsius’s non-prosecution agreement, and Mashinsky’s indictment are available here, as are the SEC, CFTC, and FTC’s press releases and indictments.
It is perhaps one of the most controversial large cryptocurrency companies. Celsius is a cryptocurrency lending platform that offers customers high-yield cryptocurrency deposits. Mashinsky explained in an interview with Bloomberg Businessweek that the reason Celsius's interest rates are so much higher than bank deposits is not because it is more risky, but because it passes more of the returns back to customers. Mashinsky said: "Someone is lying, either the bank is lying or Celsius is lying."
Last summer, Celsius froze customer withdrawals and filed for bankruptcy. Currently, Celsius faces four long-running federal lawsuits detailing its operations and problems, which I discuss below. But these are just addenda to that sales pitch. "Either the bank is lying or Celsius is lying" is enough to sum up the understanding of Celsius.
An AI model was able to write all four indictments with just this sentence. In fact, everything Celsius does is contained in this sentence in some way.
Celsius allegedly engaged in two related investment scams: First, they encouraged customers to deposit cryptocurrency deposits into Celsius with the promise that they could earn safe returns of up to 17%, which would then be loaned out to cryptocurrency hedge funds. Second, Celsius’ tokens were billed as quasi-stocks through which investors could bet on Celsius’ success.
Allegedly, these businesses were fraudulent, as Celsius could not offer a safe 17% yield (obviously!), and the tokens were allegedly a common penny stock promotion scam: Celsius was accused of exaggerating the benefits of its business to get people to buy its tokens. Here is a summary from the SEC:
“Celsius marketed two core investment opportunities to investors. First, Celsius offered and sold its own cryptoasset security, CEL. Defendants promised high yields to investors who purchased CEL and promoted CEL as an investment in Celsius’ own success. Second, Celsius offered an “earn interest program” in which investors deposited their cryptocurrency with Celsius in exchange for interest payments. Defendants promised investors in the “earn interest program” returns of up to 17 percent.
Defendants made numerous false and misleading statements in order to induce investors to purchase CEL and invest in the “interest-earning scheme.” Among other false statements, defendants made misleading statements about Celsius’ core business model and investor risks, claiming that Celsius would not make unsecured loans, that the company would not engage in high-risk transactions, and that interest payments to investors would account for 80% of the company’s revenue.
These statements were all false. Celsius could not consistently generate enough revenue to cover the required interest payments to investors associated with the “earn interest scheme.” The company engaged in high-risk trading and made unsecured loans in an attempt to generate the necessary revenue, which put the entire Celsius enterprise at serious risk. Celsius failed to succeed and as a result often paid more than 80% of its revenue to meet the company’s interest payment obligations, a business practice that was hidden from investors, was unsustainable, and ultimately led to the company’s collapse. These things were intertwined: lying to customers in order to get them to deposit money made the company look better in front of CEL investors, while raising the price of CEL made Celsius’ balance sheet look better, thereby attracting more customers. (In addition, Celsius partially paid the interest owed to customers in the form of CEL tokens, so the higher the value of CEL tokens, the easier it was to pay customers’ interest.)”
Let's start with their business model. Celsius promised customers that if they deposited cryptocurrencies, Celsius would pool those cryptocurrencies and then offer them to institutional-level cryptocurrency investors as collateralized loans in a low-risk manner. Celsius claimed that they earned interest from these loans and gave 80% of it back to customers. But the question is, how can you get up to 17% interest on low-risk collateralized loans? This makes people question. Either the bank is lying, or Celsius is lying. Which one is it? The SEC said:
“A core tenet of Celsius in promoting its business is that it does not make unsecured loans while leveraging investor funds in an “earn interest program.” Celsius and Mashinsky made this claim frequently on multiple different channels. For example, during a livestream event on November 26, 2019, Mashinsky said, “I can tell you there are other borrowers in the market who are doing unsecured loans or borrowing from anybody. Good. Great for them. We would never do that.”
In fact, despite numerous public assurances to the contrary, Celsius conducted numerous unsecured institutional-grade borrowings totaling millions of dollars. In fact, as of November 2019, Celsius had over $17 million in unsecured institutional borrowings.
Celsius expects unsecured institutional borrowings to range between $1.3 billion and $1.96 billion by 2022, representing 34% to 48% of the company’s entire institutional-grade borrowing portfolio.”
Celsius has enough compliance staff that
(1) They knew Mashinsky was lying
(2) They tried to stop him, but they were powerless
In an exchange on the Slack messaging app, a Celsius executive told a senior company employee: "I just told (Mashinsky) that the amount of unsecured loans is increasing and the overall collateral ratio to institutions is going down. ... I'll talk to him about it. I've said this multiple times." The executive sent the message because Mashinsky made false statements about the company's loan portfolio during a Nov. 6, 2020 AMA event.
Mashinsky conducted a weekly livestream event called “Ask Mashinsky Anything” (“AMA”) in which he would make false statements about Celsius’ collateral, which Celsius would then later edit to remove the lies:
In an AMA on May 14, 2021, Mashinsky claimed: “These loans we provide are all collateralized, which means that before we provide digital assets to institutions, they provide Celsius with some assets or dollars as our guarantee. This is done to protect the interests of the community and ensure that their funds are safe.”
Surprisingly, however, during the editing of the AMA, a Celsius executive directed that Mashinsky’s May 14 statement be removed. The executive recognized the falsehood of Mashinsky’s public statements and stressed that “it is extremely important to remove this portion of the AMA and ensure that the curated video explanation has been removed from all corners of the internet.”
Thus, Celsius allegedly misrepresented the safety of its loans. This is actually quite significant. When Celsius finally filed for bankruptcy, it reported assets of $4.3 billion (including loans totaling $930 million and a $310 million provision for bad debts) and customer liabilities of $4.7 billion (out of $5.5 billion in total liabilities); the loans turned out to be far less secure than Celsius had advertised, and therefore it was unable to adequately fund its customers.
However, Celsius also allegedly made false claims about the profitability of its loans: despite making risky unsecured loans, it was unable to actually generate enough revenue to pay the returns it promised its customers:
Mashinsky and other Celsius executives worried that if the company lowered the interest rates it paid to participants in its Earn Interest Program, it would cause investors to flee. As a result, Celsius set its interest rates largely to attract and retain investors, rather than based on the returns it could earn from its business activities.
Contrary to Defendants’ repeated claims that 80% of revenue was paid out to investors, Celsius consistently paid interest in excess of the revenue the Company generated.
This fact was well known to Celsius executives, including Mashinsky. For example, in February 2021, Celsius’s CFO sent Mashinsky a financial document showing that in 2020, Celsius paid $45.7 million in interest (called “incentives”) but generated only $42.7 million in revenue. In other words, more than 100% of Celsius’ 2020 revenue was used to pay so-called interest to investors.
In 2021, Celsius paid 23% more in interest to investors in its Earn Interest Plan than it generated in revenue.
So Celsius was losing money while telling investors in its quasi-equity CEL tokens that it was making money, which is bad. But there’s another question: if you raised money from customers by promising high returns, and then your revenue wasn’t enough to pay those returns, but you paid them anyway… where did you get the money to pay those returns? If the answer is “venture capitalists bought stock in your company and used their investment to pay the returns,” or “your wealthy CEO invested a portion of his own money to keep customers intact,” that may or may not be misleading, depending on your disclosures, but those are basically good answers.
Here is Celsius’s answer, of course explicitly written:
Mashinsky and Celsius’ senior leadership were aware that the company’s payout ratio was over 100%, with one executive noting that Celsius was “basically using user balances to pay user rewards.”
That's a bad answer! There's a name for this! If you raise money from customers and promise 17% returns, then you don't make enough to pay those returns, and then you raise more money from new customers and use some of that money to pay the returns, that's a Ponzi scheme. Maybe you don't intend to run a Ponzi scheme, but if you go around saying "we use user balances to pay user rewards" then you definitely have some idea of what you're doing.
Thus, Celsius told customers it was making safe investments to earn high returns, but it allegedly actually made high-risk investments and also ran a number of Ponzi schemes to earn those returns.
Then there are the CEL tokens. The SEC said:
Since Celsius was founded, their token CEL has played a key role in the company. In a white paper in March 2018, Celsius described CEL as the backbone of their platform. CEL is a token that unlocks discounts and features on the Celsius platform, so the more people use the platform, the higher the demand for CEL.
During a livestream on March 8, 2018, Mashinsky further explained: “We’re focused on driving growth for the community because everything we do is measured in [CEL] tokens.” He continued: “When the price of the token goes up, our entire reward is in that token. So our goal is to do whatever it takes to increase the price of the token as long as it’s in the best interest of the community.”
Mashinsky also publicly viewed the price of CEL as a measure of “Celsius’ profitability and operational health.” In other words, when Celsius succeeds in attracting more users, the price of CEL will rise, and when demand for Celsius’ investment services decreases, the price of CEL will fall.
Consistent with their public statements, Mashinsky and other members of Celsius viewed CEL as similar to the stock of a public company. Mashinsky wrote in an internal message that he wanted to “be able to discuss CEL like a public company.”
I agree with Mashinsky: CEL tokens have somewhat debatable utility (can be seen as commodities), they can do certain things on the Celsius lending platform, but in reality they are just Celsius shares. When Celsius business is booming, people have more confidence in Celsius and believe in its future, which drives up the price of the tokens. The tokens are like stocks, a bet on the Celsius business.
Therefore, like any publicly traded company, if Celsius lies about its business and financial condition, it is securities fraud. For example, the SEC cites Mashinsky’s statement in an April 2022 CNBC interview, in which he claimed that Celsius had 1.7 million users, when in fact it had less than 500,000 users. Or in May 2022, Mashinsky tweeted that "Celsius has not suffered any significant losses and all funds are safe", while the SEC stated:
On May 9, 2022, just two days before Celsius and Mashinsky issued their reassuring statement, a Celsius executive described the company as a “sinking ship.”
In Slack exchanges on May 12 and 25, 2022, the same Celsius executive wrote, “No hope…no plan” and that Celsius’ business model was “fundamentally problematic.”
Another employee put it bluntly in an internal message dated May 21, 2022: “We don’t have any profitable services.”
Mashinsky was aware that Celsius’s continued viability was in doubt. “We will continue to be in trouble for several more months, with asset/liability gaps now more severe and balances lower,” a Celsius executive told Mashinsky in a May 25, 2022 message.
This is a standard case of securities fraud.
Celsius is allegedly accused of manipulating the price of CEL tokens by secretly purchasing them on the open market. There is a strange mechanism in place because there are two ways to buy and sell CEL tokens. "Qualified U.S. investors can purchase and sell CEL tokens directly through the company's over-the-counter (OTC) desk," the SEC said. If you buy through the OTC desk, your tokens will be locked for one year due to securities laws. But CEL tokens are also listed on various cryptocurrency trading platforms. Trading platforms are public, while OTC desks are not, and because of the lock-up period, CEL tokens sold through OTC cannot be traded immediately on the open market. "Because these (OTC) transactions occur on the Celsius platform, they are only reflected in internal records and not on the blockchain or to other users of the Celsius platform."
Therefore, there is a manipulative trading situation:
Celsius is offering 1 million tokens for sale over the counter at $1 per token.
It could then use that $1 million to buy back slightly fewer than 1 million tokens on the open market, pushing the price up to $1.05 per token.
This was bad for Celsius in terms of corporate finance: it issued more tokens than it repurchased; it sold tokens at low prices and repurchased them at high prices.
However, because Celsius’s buybacks reduce supply on the open market and push up prices, while its OTC sales do not immediately increase supply on the open market or push down prices, this leads to manipulated CEL price increases.
Since Celsius’ treasury reserves are primarily composed of CEL tokens (which are simply created by Celsius), driving up the price of CEL makes Celsius look larger and more reputable, and provides it with more financial flexibility: driving up the price of an asset you control makes you richer.
Additionally, in Celsius’ next over-the-counter sale of 1 million tokens, it will be available for sale at the new market price of $1.05.
According to the SEC, this is how Celsius described its manipulative scheme in the memo.
An internal memo listed the “primary argument” for raising CEL prices, saying: “We are in lockstep with the rise and fall of CEL” and “the more customers use CEL and the more valuable it becomes, the more value we can extract from it (e.g., using it to pay interest rather than using our cash)”.
The internal memo describes a plan to increase the price of CEL. The plan includes an example of value-based buybacks, where Celsius will "repurchase a percentage of CEL sold through the OTC on a case-by-case basis, depending on our cash needs." The memo also details a plan to add "value" to CEL through increased trading activity by Celsius:
-The more we sell CEL through OTC
-The more CEL we can buy back
-The more attractive the CEL market is
-The more CEL orders we receive
- Ultimately: the more valuable our reserves are
- We need to sell fewer CELs, but still raise the same amount of funds
There’s something alarming about this business plan, and while it’s not exactly a Ponzi scheme, it’s similar. It reminds me of the “box/black box” mentioned in Sam Bankman-Fried’s explanation of how to run a cryptocurrency scam. He says that you can create a token, own most of it yourself, and manipulate the price to keep it high by trading it on public exchanges. This manipulation will cost you money because you’ll be buying your own tokens at irrational prices to drive up the price, but it will increase the paper value of your unsold tokens, making you appear to be very wealthy on the surface. However, if you try to sell all of these tokens to realize your wealth, their prices will collapse - because they’re just your fictitious tokens! You may end up with nothing. But if you have a lot of paper wealth, you can turn it into real wealth in other ways, not just by selling it. You can pledge it, or just say “Hey, look, I have billions of dollars in assets, you must be able to lend me more money.”
If Celsius has billions of dollars of CEL tokens in their financial reserves, they can use that as the basis of their business. They can use these valuable CEL to pay interest to their customers. They can raise cash by selling some CEL over the counter with a one-year maturity limit. They can entice customers to lend them real money by saying "our balance sheet is very strong, look how valuable our assets are." If you have a lot of assets, you can attract more assets. You may be tempted to manipulate the value of your assets.
By the way, the quotes above are mostly from the SEC complaint, although the DOJ, CFTC, and FTC are involved in similar content as well. This mostly reflects my personal opinion: I think this is primarily an SEC case because it feels like a very classic securities fraud case to me. Celsius allegedly did two things:
First, they told people "Give us your money and we will invest it for you and make 17% risk-free," and then they lost that money.
Second, they told people "We're a great company, buy our stock," but they lied and manipulated the stock price. The first thing is just a classic investment scam; the second thing is a classic penny stock pump and dump. This is all common fraud for the SEC, and for the DOJ (since the SEC can't bring criminal charges).
That’s my personal opinion, and obviously the SEC’s opinion. But in the crypto space, many people and some government officials believe that neither of these things constitute securities fraud. Crypto exchanges like Coinbase and Gemini argue that a pooled crypto lending platform that promises interest is not a security. And legally, the CEL token may not be considered a security because it’s not actually a stock, but a utility token on the Celsius platform. In general, there’s a jurisdictional dispute, with the SEC wanting to regulate almost all crypto tokens, and the crypto industry wanting the SEC to stay out of crypto. So while Celsius may have committed a serious fraud with its lending platform and tokens, there’s still a pretty heated debate about whether that fraud constitutes securities fraud.
However, in this case, it doesn’t matter! Maybe it’s just commodities fraud, but the Commodity Futures Trading Commission (CFTC) is handling it. Maybe it’s just general fraud against consumers, but the Federal Trade Commission (FTC) is handling it. Maybe it involves wire fraud, but the Department of Justice (DOJ) is handling it. Four US federal regulators have already said “whatever fraud you think Celsius is engaging in, we don’t like it”. Other cases may involve details like philosophy and jurisdiction. But someone will take action against Celsius.
