The Breakdown - Giving Up the Ghost? It’s Chapter 11 Time for Celsius

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, July 14th, and today we are back on the crypto side of the house with the latest on Celsius's imminent bankruptcy proceedings. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure as always. In addition to them being a sponsor of the show,

Starting point is 00:00:53 I also work with FTX. Lastly, this week, I am very pleased to welcome Ava Labs as an additional sponsor. Did you know that you can bridge Bitcoin natively across the Avalanche bridge to take advantage of the growing DFI ecosystem on Avalanche? This is just one of the innovative features of CORE, the new non-custodial browser extension and wallet developed by Ava Labs. Core is engineered for Avalanche users to have the most secure and seamless Web3 experience. Easily swap assets, display your NFTs in style, and store your assets in a ledger-enabled wallet. Plus, you can put real dollars in your core wallet in just a few clicks. to Core. app to access the full power of Web3 on Avalanche. Well, friends, it appears that we have fallen into a bit of a pattern, haven't we?

Starting point is 00:01:40 One day, there is some big macro news that makes us pay attention to the larger Tradfai context, and then the next day, of course, we have to race back over to crypto to catch up on some big thing that happened here that's shaping internal narratives. That's certainly the story today, as you'll see. And really, I think that this is a fairly good representation of where the crypto space is as an industry. All markets are having their context set right now by the Fed's radical shift away from the loose monetary policy of the last 12 years into an era of tightening, higher interest rates, removed liquidity, et cetera, et cetera, et cetera. Now, obviously, risk assets in the areas of the

Starting point is 00:02:17 economy that benefited most from the previous regime are the hardest hit. But the impact is truly everywhere across all assets. However, in crypto, as risky an asset class as there is, at least from the vantage point of traditional investors who had started to nudge their way in during the last couple of years, there is another force working its way through the system. That is the fallout and contagion of a number of key institutional failures. I'm speaking, of course, about Luna and UST, about Three Arrow's Capital, about Voyager, and about Celsius. I did Tuesday's show about Three AC as well as a bit of a catch-up on Celsius, and frankly

Starting point is 00:02:55 hadn't intended to cover them again so soon, but news has forced our hand. So where we left the story, Celsius was running around repaying smart contracts to unlock their locked collateral. Because of the over-collateralized nature of defy, repaying those loans make simple financial sense. If you can pay back a $100 million worth of a loan and get back $200 million worth of Bitcoin, that can be super valuable, especially going into a more traditional bankruptcy proceeding. And that's kind of what the speculation was at the time of that recording, that Celsius was effectively trying to do what it could in terms of its smart contract-based loans before it had to potentially go through the process of renegotiating creditors

Starting point is 00:03:34 in the case of a traditional bankruptcy. And indeed, that's where many thought they were headed. On Tuesday, the Vermont Department of Financial Regulation, or DFR, alleged that Celsius was, quote, deeply insolvent. In a statement, they said Celsius deployed customer assets in a variety of risky and illiquid investments, trading and lending activities. Celsius compounded these risks by using customer assets as collateral for additional borrowing to pursue leveraged investment strategies. The Vermont regulator then went on to allege that Celsius had been engaging in, quote, an unregistered securities offering by offering interest-bearing accounts to retail investors. They also said they lacked the appropriate money transmitter license.

Starting point is 00:04:12 And when push came to shove, this assessment of Celsius as deeply insolvent was not just from Vermont. On Wednesday, Celsius announced that it had filed for Chapter 11 bankruptcy protection in the bankruptcy court for the Southern District of New York. Notably, it informed regulators of this application. Chapter 11 is a voluntary bankruptcy procedure, where creditors are prevented from making claims against a company while they attempt to restructure their debts. The court will oversee the process, which involves creditor input

Starting point is 00:04:39 and agreement regarding offers of delays and repayments, reduced interest payments, or even haircuts on initial principal loaned or deposited in the case of retail customers. In a statement released on Wednesday, Celsius stated, Today's filing follows the difficult but necessary decision by Celsius last month to pause withdrawals, swaps, and transfers on its platform to stabilize its business and protect its customers. Without a pause, the acceleration of withdrawals would have allowed certain customers, those who were first to act, to be paid in full while leaving others behind to wait for Celsius to harvest value

Starting point is 00:05:10 from illiquid or longer-term asset deployment activities before they receive a recovery. CEO Alex Machinsky said in the statement, this is the right decision for our community and company. We have a strong and experienced team in place to lead Celsius through this process. And so on and so forth. Obviously, this is just company speak, and the people who have their money locked up on Celsius may not feel exactly the same. Court filings declared assets between $1 billion and $10 billion,

Starting point is 00:05:36 and liabilities in the same range. They also declared over 100,000 creditors, of course, including all of their customers. We don't yet have an itemized list of assets and liabilities yet, though, so these are just ranges. Celsius currently claims to have $167 million of cash on hand to, quote, support certain operations during the restructuring process. It claims that it is proceeding through the Chapter 11 process to allow it to continue operating, quote, in the normal course, including paying and providing benefits to employees. Through using a Chapter 11 application, Celsius seems to be attempting to avoid an outright liquidation of assets. In times like these, security of your assets should be your number one priority.

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Starting point is 00:07:41 When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. So I think here it's worth pausing to note a couple of things. The first really important part of this story is, of course, the specific managerial decisions that Celsius made and the risk that it took with customer assets. Remember what that statement from Vermont said. Celsius deployed customer assets in a variety of risky and illiquid investments trading and lending activities. Celsius compounded these risks by using customer assets as collateral for additional borrowing

Starting point is 00:08:16 to pursue leverage investment strategies. The point here is that management at this company made a specific set of decisions about how to use its funds and customer funds in order to try to get the yield that it promised customers. A lot of this story is about those decisions, and more broadly, the unrealistic, unsustainable expectations of quote-unquote yield, if you can really even use that word, that this last bowl market created. A big part of this unwind is also an unwind of what those expectations should have been and should be going forward.

Starting point is 00:08:46 The second dimension of this story, though, is of course the inherent risk of putting your crypto anywhere other than on hardware wallets where you control the private keys. This is true for leaving your coins on exchanges and it's true for third-party services, even for companies that are run well. Look, I'm a big, big believer in people's ability to make decisions for themselves about the risks that they are and aren't willing to take. it's why I bristle so hard at the entire way that we discuss investor protections. I find our entire dialogue around investor protections to too often reduce people to either being too poor to make risky decisions or rich enough to make risky decisions. When it comes to using your crypto for things that aren't just hoddling, I've always and continued to be in the camp of people should make their own decisions.

Starting point is 00:09:29 Nexo, another company in this space, has been an incredibly long-duration sponsor of the show, and so far have proven a lot more resilient than some other. in their space. I'm still proud to have them as a sponsor. But that doesn't mean that anyone should use NXO or any other service without understanding that there are risks. The first thing that they teach kids in middle school and high school about economics is there's no such thing as a free lunch. But for those who are worried that all regulations are going to be bad for this industry, one thing that is very likely to come up quite quickly, especially from the perspective of investor protections is the way in which customer assets will be treated in the context of a bankruptcy.

Starting point is 00:10:09 Now, that could mean that third-party firms, be they exchanges or other types of services, might have to specifically segregate customer assets. It will almost surely at least mean a clear disclosure regime that lets people know what risks they're taking on. I certainly don't wish Celsius ill. In fact, I hope that their strategy of getting this collateral out of the defy protocols will end up with a bigger portion of their customers being made whole or at least partially whole in the days and weeks and months to come. Now, speaking of regulations and staying in the regulatory realm for a moment, here's one that has been much talked about on Twitter, but I think for perhaps the wrong reasons.

Starting point is 00:10:46 Former Ripple advisor Michael Barr has been confirmed as the Federal Reserve's new vice chair for supervision. This position is in many ways one of the most powerful jobs in financial regulation. It involves the oversight of the U.S. banking system, as well as large non-bank financial entities under the 2010 Dodd-Frank Act. What this means practically is that Barr will have a large role in regulatory decision-making regarding the crypto industry and especially stablecoins. Now, for a bit of background, Barr was a key treasury official in the Obama administration, and in 2015, he took a role on the advisory board at Ripple Labs, saying that he thought, quote,

Starting point is 00:11:20 innovations and payments can help make the financial system safer, reduce costs, and improve access and efficiency for consumers and businesses alike. It is for this reason that in particular particular, the XRP Army is very excited about this appointment. However, it's not entirely impossible that his opinions on crypto in general may have hardened since then. He's widely viewed as a consumer advocate who supports aggressive regulation. In 2020, he co-authored a research paper that claims that proof of work assets like Bitcoin, quote, not only generate huge mining costs, but are also inefficient in their long-run design. The big thing is that the Fed is expected to make a decision on issuing a digital dollar or CBDC during his tenure.

Starting point is 00:12:00 His academic work indicates that he believes that a CBDC could boost the government's financial inclusion aims. And so while the ripple folks out there that I'm seeing on Twitter are convinced that this means that XRP is about to be enshrined by the government, I think it's much more likely that he takes lessons from his time watching the industry and puts them into designing a bespoke, customized, fully owned, fully centralized digital dollar system. However, if you are one of those folks in the XRP Army, there was still an interesting update for you this time in Ripple's case against the SEC. There was a major intermediary ruling made focused on whether emails from former SEC official Bill Hinman are protected by attorney-client privilege or are otherwise irrelevant to the case, meaning they wouldn't be able to be relied upon by Ripple in arguing their case.

Starting point is 00:12:49 The emails contain legal advice provided to Hinman while he was drafting a speech made in 2018. That was the famous Hinman speech in which he said that Ethereum use did not constitute securities transactions. The court has now ruled that the SEC must hand over these emails to be used as evidence in the case. And given that this case will provide significant judicial precedent around whether crypto assets are dealt with as security once it concludes, this is a big deal. Interestingly, the judgment isn't just a judgment, but in fact represents a pretty significant condemnation of the SEC. The judgment from magistrate Judge Netburn reads, this question is made unnecessarily complicated by the SEC's litigation tactics. The SEC has distanced itself from the speech to avoid discovery

Starting point is 00:13:32 and sought to preclude Hinman's depositions on the grounds that whatever he said in the speech, it had nothing to do with the SEC's position. The hypocrisy in arguing to the court on the one hand that the speech is not relevant to the market's understanding of how or whether the SEC will regulate cryptocurrency, and on the other hand, that Hinman sought and obtained legal advice from SEC counsel in drafting his speech, that the SEC is adopting its litigation positions to further its desired goal, and not out of a faithful allegiance to the law.

Starting point is 00:14:02 This sort of rebuke of a government agency from a judge is highly out of the ordinary and could perhaps indicate that they are frustrated with the SEC's conduct in this lawsuit. Remember, the government is supposed to act as a model litigant when it goes to court, and it appears that this judge, at least, has come to the conclusion that the SEC is falling well short of that standard. Now, this is a very small part of this overall lawsuit, and ultimately the judge's opinion on the SEC's legal strategy is, as we would say in the Magic the Gathering world, flavor text, not rules text. But it's interesting to see that the crypto industry is not alone and becoming frustrated with the

Starting point is 00:14:37 SEC's conduct in regulating cryptocurrencies. Jake Trevinsky sums it up thusly. This is strong language from Judge Netburn. It's ordinary for enforcement agencies to lose motions in court, but quite unusual for a judge to call them out for unseemly litigation tactics. It's sadly consistent with reports from across the industry of unfair treatment by the SEC. Now, as we wrap up today, I will say that there is probably a big grain of salt that you need to take any of my analysis as it relates to legal matters with. That's why I try to stick to other people's opinions like Jakes. And I will also say that there is something

Starting point is 00:15:12 representative about the legal minutia that we're starting to see come up on the breakdown and feel relevant for the show. There is, of course, so much happening. on the biggest macro levels, right, from the 10,000-foot view. But ultimately, a lot of where the industry lands on the other side of this process is going to be shaped by these small details. For now, I want to say thanks again to my sponsors, nexus.io, chain aliasis, FTX, and Avalabs. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Giving Up the Ghost? It’s Chapter 11 Time for Celsius

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