The second domino in crypto's "Great Panic" has fallen

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This is not a drill. This would be DEFCON-1.

One of crypto's largest centralized lending platforms or "digital banks" just took the dire step of freezing withdrawals in order to reach a "better position to honor, over time, its withdrawal obligations," according to a late Sunday night press release from Celsius.

With about $12 billion in assets as of this week, Celsius is in a league of its own. In fact, back in April the company put out a press release boasting that with more than 150,000 bitcoin, "Celsius holds more than MicroStrategy, Galaxy Digital, and Coinbase."

Crypto Uncomplicated Author Zack Guzman (left) interviews Celsius CEO Alex Mashinsky (right) in a June 2021 Yahoo Finance interview. (Source: Screenshot)

So, yeah, when it all of a sudden says it needs to stop customers from withdrawing assets in order to "honor" its "obligations"... it's a major problem.

There are a number of factors that may have sparked a bank run on Celsius. And if you've been reading this newsletter, you might not be surprised to find out that one of the dots is connected to the $40 billion dollar implosion that took down Terra last month.

The dots are connected in that Celsius had about $500 million of its assets (presumably customer funds) in Terra's Anchor Savings Protocol, which was promising a 20% yield on deposits. Celsius was among one of the first to withdraw its assets from Anchor when the UST stablecoin dipped below its peg of $1. Presumably, Celsius took a haircut on the $500 million it had deposited considering UST had dipped to nearly 90 cents by that point.

As people realized Celsius had exposure to the UST/LUNA implosion, the fear around Celsius potentially not having the liquidity to meet customer withdrawals began to grow. On crypto Twitter, many users began raising the flag around Celsius and the fact it likely lost money there and in a couple other exploits to the tune of tens of millions of dollars. Celsius CEO Alex Mashinsky, who I have interviewed a number of times, feverishly fought back any doubt beginning to seep through to the masses with tweets of his own.

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From a macro point of view, you probably only need to know one thing: It's not good when one of the largest lenders seizes up. Think about what happened to Lehman Brothers in 2008. Granted, Celsius is not technically a bank (because it doesn't have a banking charter, and thus, isn't regulated like a bank.) Because it's not regulated like a bank, nobody really knows how much trouble it was/is in, except for, well, Celsius.

As such, Celsius users are kind of flying blind here. How are they supposed to know if their deposits are safe? If Celsius goes under, what happens to their funds? Well, if it's any indication, people somehow only recently realized the answer to that question is the same for competing centralized crypto platform Coinbase: You're SOL. It's a point I tried to make in a prior interview with Mashinsky last June:

That's kind of why it's so important to remember the crypto tenet "Not your keys, not your coins." In plain English, all it means is these centralized platforms basically hold your crypto for you. The number of bitcoins or ether displayed in your Coinbase or Celsius account is really just an IOU. If they go poof, or take a haircut on funds they hold, your funds go poof or take a haircut (or, they can freeze withdrawals as is the case here, which is a real pain when it comes to wanting to sell in a panic.)

Long story short, this is a good and easy reminder as to why moving your crypto off exchanges is a good idea. Self custody wallets, like Trust or MetaMask, allow you to control the keys to your wallet yourself. That means you're always in control of your crypto.

Long story long, Celsius is in a bit of a pickle. It used its own token to help deliver rewards to customers on its site. That token, CEL, has plummeted 67% in the last week as user withdrawals have piled up. The decision to freeze withdrawals now is only expected to spark even more withdrawals if and when they are reactivated.

It's the same thing we observed in the bank run that caused UST to drop from $1 to 50 cents to $0. In a system where there is no backstop like the Fed or the FDIC to guarantee deposits, panic begets more panic. In other words, shutting the fire exits when everyone is trying to escape a burning building does not stop the urge to leave, it only intensifies it. And given the fact that only Celsius would've had the necessary information to make a call as serious as freezing withdrawals, it doesn't instill any sort of confidence on the part of its retail customers to keep funds there.

There is a bigger picture story here when it comes to the entire crypto ecosystem. Mainly, Celsius may have been one of the first whales to exit its UST position when it dipped from its $1 peg to 90 cents. That may have saved it from sure disaster. But, ironically, it looks like it was another pool of assets that now has Celsius behind the eight-ball. (If you truly want to go down the rabbit hole, I recommend this thread.)

It's unclear what kind of levers Celsius will need to pull in order to steer the ship properly from here, but it appears that its hull is damaged and it's taking on water. In what has already been a brutal sell off, it's likely that Celsius might need to offload some holdings in order to make good on customer withdrawal requests. That could add fuel to take the entire market down even farther from here.

As I said, in a world with no backstop or lender of last resort, panic begets more panic. Just take note of any short-term liquidity needs, and as always, post any further questions in the comments!

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