Thread by Adam Levitin

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🧵 on #CelsiusNetwork and bankruptcy. Buckle up. 1/
Here's what’s going to happen with Celsius’s customers in a Celsius bankruptcy. (I'll explain later why it's very likely to end up there.) 2/
There are two groups of Celsius customers:

One group has just made loans (Earn) to Celsius.

The other group has their assets held in an omnibus custody wallet.

(Some folks might be in both buckets.) 3/
The first group includes all of Celsius's foreign customers as well as any domestic customers who chose to use the Earn product. These folks have just made loans to Celsius. That means they are unsecured creditors of Celsius. And they're going to get shafted. 4/
Unsecured creditors will recover a pro rated share of whatever assets are left after (1) all secured creditors have been paid and (2) all of the administrative costs of the bankruptcy have been paid (lawyers, financial advisors). It’s not a happy place to be. 5/
fwiw, I don’t know if Celsius has any secured debt—it’s a Delaware entity, and Delaware (grrrr) doesn’t let members of the public do UCC searches. 6/
The custody wallet folks are trickier. They might be unsecured creditors or might not. The law here isn’t very clear. I have a paper on that group: papers.ssrn.com/sol3/papers.cfm?abstract_id=4107019
/7
Even if the custody wallet customers “own” their crypto and therefore aren’t unsecured creditors, they’re still not going to be liquid for a while. Like probably months. 8/
It’s really anyone’s guess how soon they will have access to the crypto in their custody wallets, so if the market has moved against them in the meantime, there’s no recourse. 9/
If the custody wallet customers “own” their crypto, they would have dibs on the custody assets (divided pro rata among them), but only to the extent those assets exist. 10/
So if Celsius was dipping into custody wallets to cover its own obligations and the funds are gone, then they're screwed. (I am not suggesting that this happened, but this sort of thing happens all the time with distressed businesses dipping into tax withholding funds.) 11/
If there's a shortfall in the custody funds, then to the extent of the shortfall, the customers are just unsecured creditors. 12/
So to summarize:
Earn customers are unsecured creditors.
Custody customers may or may not be unsecured creditors, but they certainly are to the extent the custody funds are inadequate. 13/
What the return on unsecured claims will be here is anyone's guess, but there’s reason to think it won’t be pretty. 14/
Here’s why (HT to @jonwu_): Celsius borrowed customer funds and used them to engage in what’s basically a carry trade: they went and borrowed DAI stablecoins via Maker DAO, pledging WBTC (that’s just an Ethereum token that is 1:1 for BTC) as collateral. 15/
Notice that for all the crypto stuff here, it's still just a good ol' carry trade going really sideways. 16/
The problem is that they risk an automated margin call if the value of the collateral falls too much. 17/
So, let’s say Celsius took $2 worth of customer funds and used it to borrower $1 of DAI, expecting that they’d generate enough of a return with the DAI that they’d be able to pay their customers the promised yield (~8%). 18/
That’s all well and good, until the value of the collateral (WBTC) starts to drop because there’s an automatic margin call when LTV=150%. 19/
Notice that if Celsius started pledging $2 of customer funded WBTC for every $1 of DAI, they’ve already lost 25% of customer funds by the time the margin call kicks in. 20/
If the margin call kicks in, there’s automatic liquidation of the position (in crypto terms, it’s a “smart contract,” but the idea of automatic liquidation after a margin call ain’t new). 21/
That automatic liquidation isn’t free. Maker DAO charges a 13% liquidation fee. That’s 13% of the collateral value, not of the loan amount. So if the margin call is at $1.50, it’s actually 19.5% of the loan amount. 22/
That would put Celsius down to $1.30, so it would have about 65¢ on the dollar of what it owed its customers (i.e., $2). 23/
And that’s assuming no recursive borrowing (using the loan proceeds as collateral for another loan). If that was going on, it's going to be much, much worse. 24/
Now Celsius seems to have decided to “gamble on resurrection” (standard insolvent company play). Instead of just closing out its Maker DAO position by repaying the loan, Celsius instead topped up more collateral. 25/
That’s actually the cheaper move if you’re liquidity constrained. You can either come up with $1 to repay the loan or add in another 12¢ (or whatever) to top up the collateral and stay above the 150% margin call threshold. If you don't have the dollar, it's an easy call. 26/
If Celsius is lucky, the BTC market will rebound and it will be able to unwind its position and avoid the 13% liquidation penalty. But if it doesn’t, then it’s kind of stuck. It cannot allow customers to withdraw their funds because it doesn’t have the money to repay them. 27/
Now Celsius does have one thing going for it: there’s no obvious immediate liquidity event. No one is about to get a judgment against them any time soon, so they can wait as long as they can make payroll (although they will surely bleed talent, if it isn’t already gone). 28/
But I think there's a decision Celsius will ultimately have to make: whether to try to sell its good assets as fast as possible (which assumes BTC falls or is steady) or to hope that BTC prices will rebound. 29/
Also part of this is @jonwu_'s observation about Celsius’s position in $stETH. It's a big, illiquid position right now, but after the move to PoS there should be a fork and maybe then realizable value… in a year or so, but who knows what ETH will be worth then. 30/
And Celsius really doesn’t have that long to wait. It's got no acute moment to trigger a bankruptcy, but it’s hard to see any business going forward. 31/
When financial institutions get into trouble, it's really, really hard to save them. 32/
The exercise now is just in loss mitigation and preparing for the storm of litigation that is coming, and that’s where bankruptcy is going to come in handy for Celsius’s directors and officers. 33/
Bankruptcy can provide an orderly forum for liquidating the assets that are salvageable and for dealing with the gamut of litigation claims. 34/
And those litigation claims (to the extent they are against Celsius) are just unsecured claims. And potentially even worse--certain securities based claims are subordinated (and registration exemptions like Celsius relies on don't affect this). 35/
But again, the tl;dr version is customers with Earn funds are unsecured creditors. Customers with custodial funds are of uncertain status, but won't have access to their funds for a while in the best scenario. 36/36
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Nic Carter @nic__carter · Jun 15, 2022
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Great thread, thanks