With the lofty goal of competing with traditional banks, cryptocurrency lending giants and their customers are now facing financial ruin due to their risk appetite and a lack of regulatory guard rails.
Celsius Network, which suspended withdrawals in mid-June, had advertised a seemingly difficult interest rate mix that charged just 0.1 percent on loans but paid more than 18 percent on deposits.
Weeks later, savings accounts totaling $11.8 billion in mid-May remained frozen.
“Celsius is going bankrupt one way or another,” said Omid Malekan, a professor at Columbia University. “Even if they get back 98 cents on the dollar for their depositors, nobody would ever want to use them.”
Since then, other operators have met a similar fate, from CoinFlex to Babel Finance, who also tried their hand at lending and had to freeze withdrawals while Voyager Digital had to restrict them.
These platforms allowed customers to deposit cryptocurrencies and either receive interest or borrow digital money using their savings as collateral.
“It’s really a shame it has come to this,” said a Celsius user who was contacted on the Reddit platform and claimed to have over $350,000 tied up with the lender.
“Clearly Celsius should have planned for this type of scenario,” the user added, speaking on condition of anonymity.
The devastating episode began with the sharp decline in cryptocurrencies, including Bitcoin, which lost nearly 60 percent of its value over the past six months.
The falling value – falling as global inflation accelerated and Russia’s invasion of Ukraine rocked the global economy – set off a chain reaction, forcing borrowers to post new financial guarantees or repay loans outright.
Some borrowers, such as Singaporean investment firm Three Arrows Capital, which is in liquidation, were unable to provide creditors with enough cash to cover withdrawals and froze customer accounts.
“The majority of these companies had provided unsecured or under-collateralized loans,” said Antoni Trenchev, co-founder of Nexo, another crypto platform that he said avoided problems by following tighter lending policies and “prudent risk management.”
Unlike banks, these lenders did not have to hold cash reserves for bad loans.
– “Great need for regulation” –
A handful of US states have opened or expanded investigations into Celsius, and some, including Alabama, have ordered the platform to stop lending to their residents over the past year.
“I expect a very strong crackdown across the board,” Malekan said. “There’s a lot of fodder for governments.”
Despite the turmoil, most observers expect cryptocurrencies to recover from the current credit woes and don’t believe it will mean an end to lending in the sector.
“It’s not the worst crisis crypto has had,” said Charles Jansen of S&P Global Ratings.
Malekan said the situation presents an opportunity to weed out weaker companies.
“During a bear market, you learn which projects have a core value proposition and solve an actual problem versus those that were just pipe dreams.”
Some, like Trechev, anticipate major consolidation in the industry, with healthy operators engulfing those that are struggling.
The episode also raised awareness of the risks of a lack of government oversight.
“There is a huge need for regulation, which everyone in the industry agrees on,” said Jansen, whose company is fighting to be recognized as a risk assessor in the crypto world.
In the absence of a specific regulatory framework, the Securities and Exchange Commission has taken the lead, but mostly with punitive measures.
Several bills aimed at addressing the need for tighter oversight have been introduced in the US Congress in recent months, but a bipartisan Senate proposal by Republican Cynthia Lummis and Democrat Kirsten Gillibrand has gained momentum.
The bill has been well received by the crypto community, particularly because it empowers the sector’s preferred regulator, the Commodity Futures Trading Commission, over the SEC.
Some critics see the proposal as too accommodating.
“It’s bipartisan in the sense that senators from different parties are pretty much giving the crypto industry what it wants,” tweeted Hilary Allen, a professor at American University’s Washington College of Law.
“It gives most jurisdiction over crypto assets to the CFTC, which has no investor protection mandate and far fewer resources than the SEC,” she added.
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