Zero degree Celsius as withdrawals frozen sending cryptocurrency markets into freefall

First there was the alleged Luna/UST market exploit and now there is Celsius…

While events continue to unfold, Celsius yesterday announced in its blog post it was invoking their terms and conditions and blocking withdrawal of funds from its lending platform:

“Due to extreme market conditions, today we are announcing that Celsius is pausing all withdrawals, Swap, and transfers between accounts.”

This immediately caused a panicked sense of Déjà Vu. After all, it was only a few weeks ago that the LUNA token lost its historic value of $50bn in only a few days from an alleged market exploit. As many in the crypto space braced themselves for a major liquidity crisis at the lending platform, panic ensued in the markets, seeing the overall market crash to below $1tr for the first time since January 2021. Was this a second black swan event and the potential for deeper system risk in the whole decentralised finance market? Or just a black signet event that would blow over in time?

On paper, Celsius looks great. Established in 2017 with 1.7m customers, raising $400m in October 2021 and releasing close to $1bn in loans, Celsius has been considered as a premier crypto lending platform. Those that owned cryptocurrencies could borrow USD against their own (higher quality) crypto.

Celsius programmatically connects crypto lenders with crypto borrowers taking a margin out of the middle. To understand the lending and borrowing processes, don’t think of it like a bank — more of a programmatic pawn broker.

- As a depositor, you could deposit up to 40 different cryptocurrencies, usually those regarded as the strongest in the market — e.g. Bitcoin, Ethereum, etc.

- Those that supported the Celsius network with their cryptocurrency deposits earned up to 17% Annual Percentage Yield (APY) dependent on perceived risks of the cryptocurrency funds deposited — the weaker the perceived token the higher the APY%.

- These deposited funds would ultimately be lent out, with the APY % dependent upon the risk of the asset offered for lending purposes and the Loan to Value Ratio (LVR), typically ranging between 25% — 50%. The higher the LVR the greater the APY level paid to depositors.

- Smart contracts did the rest. If the collateral value fell below a given level, the collateral would be automatically liquidated, sold and returned to depositors.

- Finally, there was an incentivisation structure in place — those that deposited cryptocurrencies would earn CEL tokens, as would those that borrowed funds. These CEL tokens had a market value on exchanges.

In bull market conditions, this worked well. When there is a generally positive sentiment in the marketplace, it showed potential for a great business model. LVR’s would, with reasonable expectation, hold up reasonably well, and while volatility is in the DNA of the cryptocurrency markets, there would be controlled liquidations. Once we entered bear conditions that dynamic changes…

For traders, there is a recognised mantra — prices take the stairs up and the elevator down. In other words, prices rise slowly, but once fear gets into a market, prices have a propensity to drop extremely quickly. The greater the holistic fear, eg a bear market, the more fragile markets become.

In recent weeks, like all financial markets, cryptocurrency markets have taken a battering. Not only have the global macro effects of rising inflation, increasing fuel costs and increasing talk of stagflation associated with rising interest rates created financial bear market conditions, there was also the further decimation of the crypto markets with the LUNA/UST debacle in early May. In a matter of days the algorithmic stable coin was subject to an alleged market attack — destroying LUNA’s historic value of $50bn in only a few days.

LUNA/UST had already placed a cloud of uncertainty and doubt over the cryptocurrency and Decentralized Finance (DeFi) markets, with confidence already subdued. Then over the weekend, the Celsius token, CEL, fell by over 50% in value as Celsius made their announcement of ceasing withdrawals.

Whilst the analysis continues to unfold, undoubtedly the fall in Ethereum prices on Friday had an adverse contributing effect to these cryptocurrency market conditions.

Without getting too deep into the technology, on Friday the development team at Ethereum announced a further delay in the next step in its much-lauded move from energy-intensive and computationally expensive Proof of Work to Proof of Stake — ultimately releasing ETH 2.0. In testing there were a raft of bugs discovered making it appropriate to further delay its release. In an already weakened market, this sent the price of Ethereum crashing. This was considered yet another delay on an ever-extending roadmap that has spoken of ETH 2.0 since 2019.

Imagine you were a depositor in Celsius protocol depositing Ethereum to be lent out . The price of Ethereum had already fallen from $3,500 USD in April (its current price at time of writing is c $1,200 USD — a 65% fall and its lowest level since January 2021). The ever-increasing fear of further loss has the potential to becomes self-reinforcing and you cannot free up your deposited ETH.

The Celsius withdrawal freeze is uncomfortable for depositors, who remain impotent as they see the value of their cryptocurrencies showing continued signs of deterioration. Undoubtedly Celsius were damned if they did something and damned if they didn’t. By invoking fromalised terms and conditions of the protocol, Celsius may have stopped the initial outflows, but they have piled deep frustration on their customer base and placed further pressure and focus on the recently fractured reputation of the entire Crypto market. Perhaps more importantly, the regulators are watching ever closely, as no doubt, are the class action lawyers.

On balance, Celsius have probably done the right thing to stop the equivalent of a bank-run. But the short- and medium-term ramifications of the events that have unfolded have thrown major question marks over the entire Defi space, begging even more questions. Is this over? Who’s next? Are the returns offered in DeFi sustainable when looking at the highly competitive returns compared to the traditional banking sector? Will depositors lose confidence in the space leading to enhanced withdrawals into cash to ride out weaker global markets? When considered on top of the challenges faced as a result of the LUNA/UST events back in May it also calls into question — to what extent will regulators have to get involved? There has already been increased regulatory involvement in the space. Or Will the industry as a whole come together to head off regulation at the pass and look more closely at centralised structures? Or are we already passed the point of no return? I suspect we are beyond the point of redemption

Either way the crypto industry is likely to be facing heavier regulatory pressure and increasingly fragile market conditions for the foreseeable future.

About the author

Tim Lea (@timothylea2 on twitter) is author of the book Down the RabbitHole, a book on the blockchain in plain English, an international keynote speaker on the strategic application of the blockchain, and an investor in NTFs and the cryptocurrency space. He is the co-founder of the Social Impact project Walking Between Worlds (@WBWNFTS on twitter) whose mission is to energise global Indigenous communities to amplify First Nations powerful voices through NFTs.

He will be releasing a free e-book imminently — Your Introductory Guide to Buying & Selling Your First NFT — (In Association With Walking Between Worlds_.

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Tim Lea

International Keynote Speaker | Author of Blockchain Book Down The Rabbit Hole | Chief Cryptocurrency Officer — Walking Between Worlds (#Indigenousart)