In an upsetting move for Celsius users, a court has ruled that all funds held in “Earn” accounts are the property of Celsius.

Since Celsius first froze fund withdrawals in June 2022, users have been waiting to see what the fate of their funds would be. Now, they know that they are unlikely to recover all (or any) of their funds. The judge’s ruling subordinates user claims to other secured claims and is a painful blow for any investors who had significant funds in Celsius’ “Earn” offering.

A 2022 Disaster that Won’t Fade Away

The Celsius collapse in June 2022 was a major event in the market. Celsius went from being one of the largest crypto lenders in the world to a major black mark on crypto and a key catalyst of the latest bear market. With interest rates like those below, the collapse isn’t surprising.

It started with rumors of Celsius’ insolvency, followed by Celsius freezing withdrawals, blaming it on “extreme market conditions.” As we know now, Celsius was insolvent and would later go on to file for Chapter 11 bankruptcy in mid-July.

In their bankruptcy filing, they reported holding between $1 and $10 billion in assets. Many of these funds were from users, and now it looks like none of those funds will be recovered.

Besides the aggressive risk-taking that occurred, the aspect that most hurt the community of users was the way executives misled the public in the lead-up to the bankruptcy. Timelines show that Celsius executives were still talking a big game until the final hour, which many are equating with running a “confidence game” in hopes that their problems would resolve themselves and that a bank run wouldn’t occur.

This general lack of forthcomingness has been a major issue with Celsius. But each piece of news gets worse and worse.

In October 2022, Celsius leaked user data on all the most recent users of its “Earn” program, a way for users to receive interest on their deposits. When 29,000 pages of court documents were released, wallet addresses, transaction histories, crypto holdings, and recent transactions were all revealed to the public.

The world of cryptocurrency heavily prioritizes privacy, making this an even bigger blow to the community. Although it was initially thought that this was a data breach or hack, it was just the routine release of data as part of a court proceeding, and Celsius allegedly did fight back against it.

Funds are the Property of Celsius?

On January 4th, a U.S. bankruptcy judge ruled that Celsius Network owns most of the cryptocurrency deposited by customers into its online platform. This was a painful but not unexpected blow to users, as it puts Celsius customers last in line for repayment.

Celsius’ bankruptcy has affected over 600,000 accounts worldwide. With this ruling by judge Martin Glenn, all $4.2 billion of crypto deposits are the property of Celsius and will be used to settle with other creditors. The terms of service put users at risk, which is unfortunate as so few people read the terms of service and many lost money as a result.

In his ruling, he wrote:

“The Court concludes, based on Celsius’s unambiguous Terms of Use, and subject to any reserved defenses, that when the cryptocurrency assets (including stablecoins, discussed in detail below) were deposited in Earn Accounts, the cryptocurrency assets became Celsius’s property; and the cryptocurrency assets remaining in the Earn Accounts on the Petition Date became property of the Debtors’ bankruptcy estates (the ‘Estates’)”.

The day after this ruling was announced, New York Attorney General Letitia James filed a lawsuit against Celsius CEO Alex Mashinsky. In her lawsuit, she accuses him of defrauding hundreds of thousands of customers.

An Indicator of Future Approaches to Crypto Bankruptcies

Of course, this ruling was met with the usual suspects trumpeting “not your keys, not your coins.” The company does not have enough funds to pay all owed users in full. Some users are continuing to fight for their coins, but it is unlikely that they will triumph.

The fine print said that any deposits into the interest-bearing accounts become the property of Celsius, and the bankruptcy judge has ruled in support of that. Celsius lured users in with the promise of up to 18% annual interest.

With this ruling, many users are losing any chance of recovering what could be their life savings. But it’s much worse than that. This could also be a harbinger of how future rulings will go. And with Chapter 11 bankruptcy proceedings coming up for FTX, Voyager, and BlockFi, this is a very significant precedent.

The absolute priority rule governs bankruptcies of this nature. Senior classes of credits with secured claims get repaid before junior classes, and equity is paid last. Based on current indications, users can expect to get paid after secured claims and legal fees, but before equity.

[Insert tweet: https://twitter.com/celsiusnetwork/status/1384156564013993996?lang=en]

The irony of the situation is that Mashinsky consistently pushed the message that banks were not the friends of retail investors, but ended up being just as dangerous for these same investors. Celsius operated with little to no oversight and misled investors into believing that it was a DeFi company. This lack of transparency and regulation cost a lot of people a lot of money.

Money is Moving Off-Exchange En Masse

As we’ve repeatedly said, counterparty risk is a major issue in the cryptocurrency space and borrowers/lenders should be wary of their counterparty’s ability to sustain itself. Because if deposits are treated as unsecured claims in bankruptcy, that changes the calculus considerably.

Below are charts of exchange netflows for BTC and ETH, both of which show spikes in outflows in November 2022 and afterward.

Cryptocurrency users who store their coins on exchanges, rather than in a personal wallet, are taking a risk. The events of 2022 have made them more aware of this and led to increased withdrawals from exchanges.

Exchanges have 3 major vulnerabilities:

1. Exchanges can be vulnerable to hacks and other security breaches, which can result in the loss of your funds.
2. Similarly, exchanges can be hacked for their data, which puts users at risk of being targeted.
3. In the case of bankruptcy, user funds may not be paid back to users in full (or at all).

Additionally, exchanges have been known to falsely freeze or restrict user accounts for various reasons, such as suspected fraudulent activity. This can be a frustrating and time-consuming process for users, who may not have access to their funds while their account is being reviewed.

For greater control over their own funds, it is generally recommended that cryptocurrency users store their coins in a personal wallet, rather than on an exchange.

Secure Digital Markets Doesn’t Take Custody

One key advantage of using an OTC brokerage like Secure Digital Markets is that we never take custody of the coins being traded. This is in contrast to exchanges, which often hold users’ coins in a central, online wallet.

Instead, SDM sends the funds to client wallets or bank accounts immediately after a trade has been executed. This makes it a safer option for traders who want to minimize the risk to their funds. Recently, we’ve seen a considerable increase in interest in OTC trading services for this exact reason.

Interested in learning how SDM can help you stay safe while trading in these volatile times? Book a free consultation today.

Secure Digital Markets (SDM) is a digital asset brokerage operating on a global scale providing OTC cryptocurrency spot trading and crypto-backed lending services to institutional, high net-worth, and corporate clients across 60+ international markets. We offer a custom pathway to digital asset liquidity and off-exchange transactions. SDM streamlines the acquisition, storage, and liquidation of digital assets in a secure and compliant manner.

Our clients use our services to unlock liquidity and take advantage of current opportunities in the market. Visit our website today to learn more about our services and how SDM can help you to maximize your digital assets.

‍