Celsius users with crypto collateral stuck turn to bankruptcy process

Alan Knitowski has an MBA, has worked in technology and finance for over 25 years, and is CEO of a Nasdaq-listed mobile software company. That didn’t stop him from getting duped by a crypto firm.

Knitowski borrowed $375,000 from crypto lender Celsius over several years and posted $1.5 million in bitcoins as a guarantee. He didn’t want to sell his bitcoin because he liked it as an investment and thought the price would go up.

It was the Celsius model. Cryptocurrency investors could essentially store their holdings with the company in exchange for a dollar loan they could use. Knitowski would get the bitcoin back when he repaid the loan.

But that’s not what happened, as Celsius, which earlier in the year managed $12 billion in assets, went bankrupt in July after a fall in crypto prices caused an industry-wide liquidity crisis. Knitowski and thousands of other loan holders had more than $812 million in collateral tied up on the platform, and bankruptcy records show Celsius failed to return collateral to borrowers even after repaying their loans.

“Every aspect of what they did was wrong,” said Knitowski, who runs an Austin, Texas-based company called Phunware, said in an interview. “If my CFO or I did anything like that, we would be charged immediately.”

Creditors are now working through the bankruptcy process to try to recover at least some of their funds. They benefited from some optimism on Friday, after Celsius announced the sale of its asset custody platform called GK8 to Galaxy Digital.

David Adler, a bankruptcy lawyer with McCarter & English who represents Celsius creditors, said the money from the deal was to be used to pay legal fees. Beyond that, there might be funds left over for past customers.

“The big question is – who is entitled to the money they get from GK8?” Adler told CNBC. Adler said he represented a group of 75 borrowers who held around $100 million in digital assets on Celsius’s platform.

Later this month, further relief could arrive as tenders open for Celsius’ loan portfolio. If another business purchases the loans, customers will likely have the option of repaying them and then having their collateral released.

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Knitowski told CNBC he elected to incur his borrowings at a loan-to-value rate of 25%. This means that if he took out a loan of $25,000, he would post four times that amount as collateral, or $100,000.

The more collateral a borrower is willing to provide, the lower the interest rate on the loan. If the borrower defaults on the loan, the lender can seize the collateral and sell it to recoup the cost. It’s like a residential mortgage, where the borrower uses the house as collateral. In the crypto world, a borrower can apply for a loan and pledge bitcoins as collateral.

Earlier this year, as bitcoin’s price plummeted, Knitowski repaid one of his Celsius loans to avoid being called on the margin and having to increase his collateral. But after that, the company did not return the bitcoin that served as collateral for this loan. Instead, the assets were deposited into an account called “Earn”. Under the company’s terms and conditions, the assets in these accounts are owned by Celsius, not the customers.

“Imagine you pay for your car, but someone keeps it,” Knitowski said. “You pay off your house, but someone keeps it. In that case, it would be like paying off the loan. And instead, you don’t get your collateral back even if it’s paid off.”

Failure to disclose

That wasn’t the only problem. The crypto platform also failed to provide borrowers with full federal disclosure of the Federal Truth in Lending Act (TILA), according to former employees and an email sent to customers on July 4. The law is a consumer protection measure that requires lenders to give borrowers critical information. , such as the annual percentage rate (APR), the term of the loan and the total costs for the borrower.

The email to borrowers stated that “disclosures required to be provided to you under the federal Truth in Lending Act did not include one or more of the following,” then went on to list more than a dozen possible missing disclosures.

A former Celsius employee, who asked to remain anonymous, told CNBC the company was retroactively trying to comply with TILA.

“You can’t say, ‘Oh, oops, we forgot about 25 elements of the Truth in Loans Act, and therefore we’ll just redo them and pray,'” Knitowski said.

Jefferson Nunn, publisher and contributor to Crypto.news, took out a loan from Celsius and posted more than $8,000 worth of bitcoins as collateral. He knows that these assets are no longer available to him even if he repays his loan.

Nunn, who lives in Dallas, said he got the loan to invest in more bitcoins after seeing a promotion for the platform. He said he heard about Celsius after doing a podcast with co-founder Nuke Goldstein. On the show, Goldstein said, “your funds are safe,” Nunn said. Alex Mashinsky, former CEO of Celsius, made similar comments shortly before halting withdrawals.

Alex Mashinsky, CEO of Celsius on stage in Lisbon for Web Summit 2021

Piaras Ó Midheach | Sports file | Getty Images

“It’s basically a mess and my funds are still locked in there,” Nunn said.

This theme has come up repeatedly in crypto, most recently with the failure last month of FTX. Sam Bankman-Fried, the exchange’s founder and CEO, told his Twitter followers that the company’s assets are doing well. A day later, he was looking for a bailout amid a cash crunch.

Although the Celsius implosion did not carry the scale of FTX, which was recently valued at $32 billion, the company’s management faced its share of criticism. According to a court filing in October, top executives withdrew millions of dollars in assets before the company halts withdrawals of customer funds.

A former employee, who asked not to be named, said there was a lack of financial oversight that resulted in significant holes in the company’s balance sheet. One of the biggest issues was that Celsius had synthetic shorting, which occurs when a company’s assets and liabilities don’t match.

The former employee told CNBC that when clients deposited crypto assets with Celsius, he was supposed to make sure those funds were available whenever a client wanted to withdraw them. However, Celsius was taking deposits from customers and then lending to risky platforms, so it didn’t have the cash to return the funds on demand.

As a result, when customers wanted to withdraw funds, Celsius would rush to buy assets on the open market, often at a high price, the person said.

“It was a huge error in judgment and operational control that really hurt the organization’s balance sheet,” the former employee said.

He also said Celsius was hoarding cryptocurrency tokens that had no value as collateral. On its platform, Celsius touted that customers could “earn compound crypto rewards across BTC, ETH, and over 40 other cryptocurrencies.” But according to the former employee, the teams responsible for deploying these coins had nowhere to go with many of the more obscure tokens.

The ex-employee said he left Celsius after discovering the company was not careful with client funds and was making risky bets to keep delivering the high returns promised to depositors.

“A lot of individuals withdrew all their money from traditional banking systems and trusted Alex Mashinsky completely,” the person said. “And now these people are unable to pay the medical bills, to pay the weddings, the mortgages, the pensions, and that continues to weigh very heavily on me and my colleagues who have left the organization.”

Celsius did not respond to multiple requests for comment. Mashinsky, who resigned of Celsius in September, declined to comment.

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