The Breakdown - Independent Examiner Excoriates Celsius as a Ponzi

Episode Date: February 1, 2023

On today’s episode, NLW breaks down the newly filed report from the Celsius Network bankruptcy court’s independent examiner. The extremely thorough document argues that not only was Celsius engaged in extremely problematic practices, but that numerous employees raised concerns around them. The show also covers the debate around an independent examiner in the FTX case.   - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26–28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Swoon” by Falls. Image credit: Malte Mueller/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

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 produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, January 31st, and today we are talking about the new Independent Examiner Report coming out around the Celsius bankruptcy. Before we dive 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 dive deep, 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. All righty, and a quick note before we dive into today's topic. I'm sure at this point you have heard about Ordinals, which is the quote unquote controversy of NFTs coming to Bitcoin or perhaps reentering Bitcoin is a better way to put it. I think that the Ordinals conversation is absolutely fascinating. There is a technical dimension of it in terms of what changes to Bitcoin over the last few years have enabled it. There is a huge Bitcoin cultural dimension to it in terms of how different parts of the community are reacting. There is a censorship debate issue. There's a long-term security debate issue. So all of this is to say that this show is definitely coming, but there's so much that I wanted to parse through

that I decided I wanted to hold off for at least one more day. Now, in the meantime, the independent examiner in the Celsius bankruptcy just dropped some absolute bombs in a filing first thing this morning, so that's where we're going to start. The report is 476 pages long and comes from Chobah Pillay, the examiner who was appointed to be a completely independent voice. To read the reporting around it, the banner headline is that it effectively accuses Celsius of having been a Ponzi, using new customer deposits to pay for old customer withdrawals. People are just starting to dissect it, and I'm drawing from a number of those threads, including one this morning from Ram Al-Alawalia of Lumido wealth.

So as I mentioned, one big theme is the Ponzi-like dynamics of using customer funds and especially new deposits to cover older obligations. From the report, quote, Celsius recognized that it should not use customer assets to purchase the coins necessary to cover liabilities to other customers, but it justified its use of customer deposits to fill this hole on its balance sheet on the basis that it was not selling customer deposits, but instead posting them as collateral to borrow the necessary coins. Celsius also used the proceeds of these borrowings to continue to purchase. a cell, which editors note is their native token. In April 2022, Celsius's coin deployment specialist described Celsius's practice of, quote, using customer stable coins and quote, growing short in

customer coins to buy sell as, quote, very Ponzi-like. End quote. Now moving farther in the report, as part of these Ponzi dynamics, it sounds like some executives were nervous about how high the rewards they were offering to the public got. From the report again, some in Celsius's management sounded alarm bells over this practice and attempted to lower reward rates. Mr. Machinsky, who prioritized growth in Celsius's customer base over profitability, however, overrode their recommendations and refused to do so. The result was that between 2018 and June 30th, 2022, Celsius accrued reward obligations to customers of $1.36 billion more than the net revenue it generated from customer deposits. End quote. Mr. Machinsky is, of course, Alex Machinsky,

the former CEO of Celsius. Now, another big theme in this report is how much Celsius was involved in trying to prop up the value of its cell token. Again from the report, quote, Another cornerstone of Celsius's marketing strategy was its promotion of its native cell token. Celsius told its customers that sell was its, quote, backbone with Mr. Mishinsky repeatedly equating the value of cell with Celsius's value. Celsius explained that it intended to raise the initial capital to fund its business by selling 325 million cell through private pre-sales and an initial coin offering, and that these sales would raise $50 million. $1. Celsius told customers that they would receive rewards in sell that Celsius would obtain

from its internal treasury, which would hold an additional $325 million, or by buying sell in the secondary market. According to Celsius, this process would create a self-sustaining flywheel. Celsius's marketing efforts would start the wheel spinning by generating more users and thus more assets for Celsius to invest. From its inception, however, Celsius in the driving force behind its operations, Mr. Machinsky, did not deliver on these promises. Behind the scenes, Celsius conducted its business in a starkly different manner than how it marketed itself to its customers in every key respect. During the height of Celsius's market making, Celsius often sought to protect sell from price drops that it attributed to Mr. Machinsky's sale of large amounts of his personal

cell holdings. As a result of Mr. Machinsky's sales, Celsius often increased the size of its resting orders to buy all of the cell that Mr. Machinsky and his other companies were selling. As Ram summed up, cell would drop when Machinsky was dumping on retail and cashing out. Celsius would step in to prop up sell token using customer funds. Now, in terms of how much Michinsky made on this, according to the report between 2018 and the petition date, Mr. Machinsky sold at least 25 million cell tokens, realizing at least 68.7 million on these sales. S. Daniel Leon, also a founder of Celsius, sold at least 2.6 million cell tokens for at least 9.74 million. It's obviously one thing for a project founder to decide to take

some risk off the table by selling tokens that they had as part of their participation in that company. It's another thing when the company is actively propping up the price of those tokens using customer deposits, and that's exactly what was happening. Again, from the report, quote, In addition to using customer deposit, Celsius also turned to the funds it was raising from outside investors to buy sell. Internally, Celsius's managers expressed concern that Celsius was using, quote, equity money to buy sell that should be strategically used to grow the company. When the examiner asked Celsius's former vice president of Treasury why Celsius brought cell to pay rewards rather than use the sell at held in Treasury, he acknowledged that the answer

lies in who holds the most sell. Another manager put it more bluntly, saying we spent all our cash paying execs and trying to prop up Alex's net worth and sell token. And this gets us to the next big theme of this report, which was fraud and deception and knowingly making untrue statements. On this part, Rom said, Mishinsky told customers that we only do asset back lending, so always have 200% collateral. In another AMA, he told customers Celsius is very, very strict who we lend to. We do not do unsecured lending. That statement shows willful deception or fraud. The CIO, CFO, and head of trading were concerned that Alex would be called a liar. There was also internal discussion of whether to edit out false statements in AMAs.

You heard it right. There were internal meetings talking about the fraud. Specifically in the context of that AMA where Celsius said we do not do unsecured lending, the report says, quote, the chief investment officer responded that Mr. Machinsky's statements were, quote, dangerous because the borrowers with unsecured loans could tell everyone Mr. Machinsky was a liar. There is a lot of emphasis on untrue statements from Mishinsky. In another part of the report, the examiner writes, Alex Mishinsky repeatedly told customers in his weekly live stream conversations that customer deposited coins are, quote, your coins, not our coins. It's always your Bitcoin. When asked what would happen in the event of a bankruptcy, Mr. Mishinsky told customers,

quote, coins are returned to their owners even in the case of bankruptcy, which, as they have painfully learned, is not true. Join CoinDesk's Consensus 2023. The most important conversation in critical Crypto and Web 3, happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web 3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, and more. Use code Breakdown to get 15% off your pass. Visit Consensus.coindex.com or check the link in the show notes.

There is also in this report definitely lots of chatter about internal folks knowing wrong was being done. From the report, Celsius's former chief financial officer wrote, We are talking about becoming a regulated entity and we are doing something possibly illegal and definitely not compliant. As one employee noted in an internal Slack communication, if anyone ever found out our position and how much our founders took in USDA could be a very, very bad look. We're using users' USDC to pay for employees' worthless sell, all because the company is the one inflating the price to get the valuation to be able to sell back to the company. So obviously there's a lot more in this. It's a 476-page document,

as I said, but here's how Ramigan sums this up. Ponzi scheme, Machinsky cashing out and dumping on retail, willful deception, TOS violations, market manipulation. Like FtX, these frauds were both more brazen than Enron. Unlike FtX, the Celsius lives were known and discussed across departments, including marketing. Decentralization works, not perfect. Regulated C-Fi works, not perfect. Unregulated non-banks, worst of both worlds. Anyway, I think there'll be a lot more on this as people dig deeper into the report, but it is not looking good for those at the top of Celsius. Now, speaking of FTC's one connection back to that situation,

as I mentioned, this report was the work of an independent examiner. In early December, the Department of Justice's Office of the U.S. trustee filed a motion asking the court to appoint a similar type of independent examiner in the FTC case. U.S. trustee Andrew Vara said at the time, like the bankruptcy cases of Lehman, Washington Mutual Bank, and New Century Financial before them, these cases are exactly the kind of cases that require the appointment of an independent fiduciary to investigate and to report on the debtor's extraordinary collapse. The examiner should investigate the substantial and serious allegations of fraud, dishonesty, and competence, misconduct, and mismanagement by the debtors.

Now, in that filing, they didn't question the qualifications, competence, or good faith of John Jay Ray. they just said that it was, quote, too large and too important to be left exclusively to an internal investigation. Seems pretty reasonable, right? Well, last week, a number of groups around FTX, including their current lawyers, the joint provisional liquidators of FTCS and the Bahamas, and a creditors committee all filed objections to the appointment of this independent examiner. The FtX lawyer said, quote, the appointment of an examiner with a mandate to be determined can be expected to cost these estates in the tens of millions of dollars. Indeed, if history is a guide, the cost could near or exceed $100 million. The creditors committee also cited prohibitive costs. However, there

are also questions of independence. Remember, on December 9th, a group of four senators wrote an open letter to Judge John Dorsey, claiming that Sullivan and Cromwell had a conflict of interest in the case. Dorsey was not impressed, and on January 20th, the judge ruled that those conflicts were not sufficient to stop S&C from acting as FTX counsel. Now, that was after some 11th hour theatrics by former FTCS regulatory head Dan Friedberg, but ultimately they didn't come to me. much. Now, when it comes to this independent examiner, the final determination will take place on February 6, and lawyer James Murphy wrote a whole threat about it. He writes, On February 6th, a key hearing will take place in the FTX case. The court will hear the U.S.

trustees' motion for appointment of an independent examiner. If the motion fails, we may never get an unbiased account of the demise of FTX. Here's what you should know. Independent examiners were appointed in both the Enron and Rescap bankruptcies, where Mr. Ray served as restructuring CEO. The Enron Examiner's report established the basis for claims against Enron's lawyers, auditors, and bankers. Both reports led to huge recoveries for creditors. An independent examiner in FTCS would get answers to key questions like, was FtX U.S. in fact, solvent on the day it filed bankruptcy? Who among the accountants, bankers, lawyers, and others bear legal responsibility for enabling the FtX fraud? Do the malpractice claims alleged by Daniel Friedberg against Sullivan and Cromwell have any validity?

How did the FtX team lose $477 million in customer assets in a quote-unquote hack, around the time of the bankruptcy filing and more. Obviously, S&C can't investigate these issues. As counsel to the debtors, S&C is objecting to appointment of an independent examiner who would investigate these questions and render a report to the public. S&C's conflicts are well documented. Any investigation they conduct would be considered inherently suspect by many. Where is the SEC? The SEC asked for the examiner in Enron, but the SEC has done nothing to support appointment of an examiner in FTX. I wonder why. Any legitimate investigation of the FTCS fraud would necessarily examine the dealings between the SEC and key figures at FTC. Where are the

politicians? To their credit, a group of four U.S. senators wrote to the judge strongly supporting appointment of an examiner for FTX. But where are the rest of them? Is there a reason the others lack enthusiasm for an in-depth investigation into SBF's activities? Where are the states? To their credit, Wisconsin and Vermont have filed papers in support of an independent examiner. But every U.S. state has citizens who were victimized by the FtX fraud. Why have we not heard? from the others. States Attorney General, it's not too late. If SBF pleads guilty, there may be no public trial of anyone connected to the FTX fraud. Without an independent examiner's report, the FTX victims may never get a truly unbiased accounting of all those who enabled one of the

largest frauds in U.S. history. Let that sink in. Now, from where I'm sitting, as much as I understand not wanting to add costly processes that could cut into the funds available for recovery, I tend to agree with another lawyer John Deaton when he writes, There are certain things in life that can be called no-brainers, and the appointment of an independent examiner in the biggest fraud case since Madoff is one of them. And by the way, I don't think you have to believe that John Ray or Sullivan and Cromwell are compromised in any way to still want an independent examiner. After everything that has happened so far, it just seems like common sense.

Anyway, there is even more going on in FTX right now. Apparently a group of senators, including Elizabeth Warren, Roger Marshall, and John Kennedy sent another letter to Silvergate asking for more information about what they knew about FTX's misuse of customer funds, saying that their answers to a similar set of questions in December were evasive and incomplete. There has also been a loud back and forth between prosecutors and SPF's legal team around a number of issues, including SPF's lawyers, arguing for some reason that Sam should have access to transfer FTX funds, which just doesn't make any sense. And on the other hand, prosecutors asking for Sam to have new conditions around not being able to

contact former employees. That comes after emails came to light that Sam had sent to John Ray, as well as to former FTX U.S. General Counsel Ryan Miller, that the prosecutors are basically saying looks like, or at least suggest the possibility of witness intimidation and tampering. Anyways, it continues to be an almighty mess, and as I've told you before, I'm going to try to steer clear of the psychodrama aspect to it and really only focus on what's really important. As we can see from the Celsius report, it feels like this independent examiner question may be one of those really important topics. Anyways, guys, I appreciate you listening as always, and until tomorrow, be safe and take care of each other. Peace.