Savers who are frustrated by the meager returns offered by banks in recent years, seemed to have found a solution: so-called crypto-loan accounts that can pay interest of 18% or even more. Millions flocked to these products offered by emerging companies, including the Celsius Network, and introduced a whole new group of investors to cryptocurrencies. Now it seems that some of these conspicuous returns may have been too good to be true. After accumulating more than $ 20 billion in assets at the top, Celsius saw the value of the deposits melt away until they were thrown into a solvency crisis – and gave another blow to the crypto world’s already shaky confidence.
What is cryptocurrency lending, and what happened to Celsius?
1. What is a crypto loan?
At first redness, crypto loan accounts look a lot like savings accounts offered by banks, but with cryptocurrencies instead of traditional money. An investor opens an account, deposits cryptocurrency and earns interest. Many deposits are in Bitcoin, while other investors use stablecoins – tokens whose price is often linked to $ 1. Others use lesser-known, more volatile cryptocurrencies. The accounts usually pay interest in the same currencies that are deposited. Some have prices that change daily. Others offer fixed interest rates and the money is locked in for a fixed period.
2. How big is cryptocurrency lending?
It is still small compared to traditional banking, but it has grown rapidly. Celsius said it had deposits of close to $ 11.8 billion on May 17, while BlockFi Inc. in mid-June declared deposits of more than $ 10 billion. Gemini Trust Co. began offering accounts in February 2021 and said in August last year that they had more than $ 3 billion in deposits.
3. How can they afford the big return?
The companies that offer the accounts say that they are able to lend customer deposits to institutional investors at even higher prices. These institutions sometimes need to borrow crypto to carry out their own trades, for example to bet that the price of crypto will fall or to take advantage of price differences in other financial instruments. But regulators have said they believe some crypto lending companies are using the money for other business activities. Some may invest customer funds in more risky crypto projects, make money on the bets and take out the difference. The point is that there are no uniform rules for companies to reveal what the deposits can and cannot be used for. The same applies to decentralized finance, or DeFi, instruments that also lure crypto investors with sky-high interest payments.
4. How do cryptocurrencies differ from DeFi?
Celsius, BlockFi and other crypto loan companies trade directly with their customers and pay them interest. With DeFi, it can only be a data code, instead of an intermediary, that manages borrowing and lending and interest payments. Lending crypto to earn interest via DeFi is sometimes called yield farming. This is again different from staking, where holders of a cryptocurrency allow their tokens to be used to help order transactions on the blockchain, or the digital ledger, used by that coin.
5. What happened to Celsius?
The last problems began after Celsius made a large investment in a stake token called stETH. StETH allows people – and companies like Celsius – to invest in the Ethereum blockchain and earn additional returns through DeFi. A sharp fall in the value of cryptocurrencies in May meant that stETH traded at a discount and the token became more illiquid. This made it more difficult for Celsius to collect money for redemptions when users wanted to withdraw their money. On June 12, Celsius announced that it was stopping withdrawals due to “extreme market conditions”, an apparent attempt to avert the digital equivalent of a bank robbery.
6. What have regulators done with cryptocurrencies?
Regulators and investors are concerned that consumers do not understand that they are taking much more risk than they would in a bank savings account. Because the crypto accounts are not FDIC insured, customers may lose their deposits if a company goes bankrupt, is hacked or otherwise loses customers’ funds. Few of the companies that offer the accounts first sought approval from US federal regulators, and this already led to a setback. In July 2021, securities regulators for Alabama, Texas, New Jersey, Kentucky and Vermont filed lawsuits against BlockFi alleging that the company offered unregistered securities. Several of the same states filed lawsuits against Celsius. Coinbase Global Inc. planned to offer similar accounts, but dropped the proposal after the Securities and Exchange Commission said it could sue the company. BlockFi announced in February that it would seek SEC approval for accounts payable to high-yield clients to lend their crypto as part of a record $ 100 million settlement with federal and state securities watchdogs.
7. What can change as a result of Celsius’ problems?
The crisis in Celsius may accelerate the regulatory decline. Financial watchdogs seem to see cryptocurrencies as some of the lowest hanging fruits in their attempts to bring law and order to the broader crypto industry. After all, with companies like Celsius and BlockFi, there is a clear entity to sue, which is not always the case in DeFi transactions.
8. What happens if cryptocurrencies are considered securities?
The term opens up for a completely new regime with registrations and disclosure requirements to make the products safer. This will probably mean higher costs for the crypto companies, and possibly the end of the huge return for investors.
More stories like this are available at bloomberg.com
