Bloomberg details the "fraud" of Celsius: Why was it sued by the four major regulatory agencies in the United States?

U.S. Regulators Sue Celsius and Its CEO

A week ago, in a report about Celsius Network, I wrote: "For the past few years, anyone paying attention to cryptocurrency has had their own personal 'Why aren't these people in jail?' top ten list." I think I can cross one name off my list:

The former CEO of the bankrupt cryptocurrency lending company Celsius Network Ltd. has been charged with fraud and sued by three regulators in connection with the company's collapse.

57-year-old Alex Mashinsky is also accused of attempting to manipulate cryptocurrency in federal court in New York. The Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Federal Trade Commission (FTC) have also filed lawsuits against Mashinsky and the company.

Here are (1) the Department of Justice's press release, Celsius's non-prosecution agreement, and Mashinsky's indictment, (2) the SEC's press release and complaint, (3) the CFTC's press release and complaint, and (4) the FTC's press release and complaint.

We have discussed Celsius a lot here, as it may be one of the most ridiculous large cryptocurrency companies. Celsius is a cryptocurrency lending platform that offers high yields on customers' cryptocurrency deposits. In an interview with Bloomberg Businessweek, Mashinsky explained that the reason Celsius's rates are much higher than bank deposit rates is not because it is riskier than banks, but because it passes more of the profits to customers. Mashinsky said: "Someone is lying," "either the banks are lying, or Celsius is lying."

Last summer, Celsius froze customer withdrawals and filed for bankruptcy. Currently, there are four long-term federal complaints against Celsius detailing its operations and issues, which I will discuss below. However, all of this is just a footnote to that sales pitch. "Either the banks are lying, or Celsius is lying" is everything you need to know about Celsius; a generative AI model could write these four complaints with just that sentence as a prompt; everything Celsius actually did is somehow contained in that sentence.

Celsius is alleged to have engaged in two related investment frauds: its business involved getting customers to deposit cryptocurrency with Celsius, promising them safe returns of up to 17%, and then lending it to cryptocurrency hedge funds; while its tokens were a quasi-stock form of Celsius, allowing investors to bet on Celsius's success. The business is alleged to be a scam because Celsius could not generate safe 17% returns (obviously!), and the tokens were allegedly a common low-priced stock promotion scam: Celsius allegedly exaggerated the advantages of its business to get people to buy its tokens. Here is a summary from the SEC:

Celsius marketed two core investment opportunities to investors. First, Celsius offered and sold its own cryptocurrency security, CEL. The defendants promised high yields to investors purchasing CEL and promoted CEL as an investment in Celsius's own success. Second, Celsius offered an "earn interest program," where investors deposited their cryptocurrency with Celsius in exchange for interest payments. The defendants promised participants in the "earn interest program" returns of up to 17%.

The defendants made numerous false and misleading statements to entice investors to purchase CEL and invest in the "earn interest program." Among other false statements, the defendants made misleading statements about Celsius's core business model and investor risks, claiming that Celsius would not engage in unsecured lending, that the company would not engage in high-risk trading, and that the interest paid to investors accounted for 80% of the company's revenue.

These statements were all false. Celsius could not sustainably generate enough revenue to pay the interest payments required to investors associated with the "earn interest program." The company engaged in high-risk trading and made unsecured loans in an attempt to generate the necessary revenue, putting the entire Celsius enterprise at serious risk. Celsius failed to succeed, often paying more than 80% of its revenue to meet the company's interest payment obligations, a business practice that was hidden from investors, unsustainable, and ultimately led to the company's collapse. These things are intertwined: to get customers to deposit, lying to them made the company look better in front of CEL investors, and raising the price of CEL made Celsius's balance sheet look better, thus attracting more customers. (Additionally, Celsius partially paid interest owed to customers in CEL tokens, so the higher the value of CEL tokens, the easier it was to pay interest to customers.)

Let's start with the business. Celsius promoted to customers that they could deposit cryptocurrency, and Celsius would pool customers' cryptocurrency to provide high-quality, low-risk loans to institutional-level cryptocurrency investors, earning interest from these loans and passing 80% of the interest to customers, but how could 80% of interest from low-risk loans reach 17%? Celsius somehow provided loans that were both safe and profitable. Either the banks are lying, or Celsius is lying. So which one is it? The SEC states:

A core principle in Celsius's promotion of its business was that it did not engage in unsecured lending while utilizing the funds of participants in the "earn interest program." Celsius and Mashinsky frequently made this claim through various channels. For example, in a live event on November 26, 2019, Mashinsky said, "I can tell you there are other borrowers in the market doing unsecured loans or borrowing from anyone. Good. Good for them. We will never do that."

In fact, despite many public assurances to the contrary, Celsius engaged in numerous unsecured institutional loans totaling millions of dollars. By November 2019, Celsius's unsecured institutional loans had exceeded $17 million.

By 2022, the amount of Celsius's unsecured institutional loans ranged between $1.3 billion and $1.96 billion, accounting for 34% to 48% of the company's entire institutional loan portfolio.

Celsius had enough compliance staff such that (1) they knew Mashinsky was lying, (2) they tried to stop him, but they were powerless:

In communications on the Slack messaging app, a Celsius executive told a senior employee at the company, "I just told (Mashinsky) that the amount of unsecured loans is increasing while the overall collateralization ratio with institutions is decreasing… I will talk to him. I have said this many times." This executive sent this message because Mashinsky made false statements about the company's loan portfolio during an AMA event on November 6, 2020.

Mashinsky held weekly live events called "Ask Mashinsky Anything" (AMA), during which he made false statements about Celsius's collateral, and then Celsius would later edit to remove these lies:

In the AMA on May 14, 2021, Mashinsky said, "These loans are all secured. This means that institutions provide Celsius with assets or dollars to hold before we provide digital assets. This protects the interests of the community and ensures their safety."

Mashinsky's statement from May 14 was deleted as part of the AMA editing process, at the direction of a Celsius executive. This executive recognized the falsehood of Mashinsky's public statements and noted, "It is critical to delete this part of the AMA and remove the curated video explanation from every corner of the internet."

Thus, Celsius allegedly falsely advertised the safety of its loans. This is actually very important. When Celsius eventually filed for bankruptcy, it reported assets of $4.3 billion (including loans totaling $930 million and a $310 million allowance for bad debts), while customer liabilities totaled $4.7 billion (total liabilities of $5.5 billion); it turned out that these loans were far less safe than Celsius advertised and could not provide enough funds for customers.

However, Celsius allegedly also falsely advertised the profitability of its loans: despite engaging in high-risk unsecured loans, it still could not actually generate enough revenue to pay the returns it promised to customers:

Mashinsky and other Celsius executives were concerned that if the company lowered the interest rates paid to participants in the "earn interest program," it would lead to investor attrition. Thus, Celsius largely set its rates to attract and retain investors, rather than based on the returns that its business activities could generate.

Contrary to the defendants' repeated claims that 80% of the income paid to investors, Celsius consistently paid interest that exceeded the revenue generated by the company.

This fact was well known to Celsius executives, including Mashinsky. For example, in February 2021, Celsius's CFO sent Mashinsky a financial document showing that in 2020, Celsius paid $45.7 million in interest (referred to as "rewards") but generated only $42.7 million in revenue. In other words, Celsius used over 100% of its revenue in 2020 to pay so-called interest to investors.

In 2021, the interest paid to participants in the "earn interest program" exceeded the revenue generated by Celsius by 23%.

Thus, Celsius was losing money while telling its quasi-stock CEL token investors that it was making money, which is bad. But there is another question: if you raise funds from customers by promising high returns, and then your revenue is insufficient to pay those returns, but you still pay… where do you get the money to pay those returns? If the answer is "venture capitalists bought shares in your company and used their investments to pay returns," or "your wealthy CEO put in some of his own money to keep customers whole," that may or may not be misleading, depending on your disclosures, but those are basically good answers.

Here is Celsius's answer, and of course, it explicitly stated:

Mashinsky and Celsius's senior leadership were aware that the company's payout ratio exceeded 100%, with one executive noting that Celsius "was essentially using user balances to pay user rewards."

This is a bad answer! It has a name! If you raise funds from customers and promise a 17% return, then the money you earn is insufficient to pay those returns, and then you raise more funds from new customers and use some of that money to pay returns, that is a Ponzi scheme. Maybe you are not intentionally running a Ponzi scheme, but if you are going around saying "we are using user balances to pay user rewards," then you certainly have some understanding of what you are doing.

Thus, Celsius told customers it was making safe investments for high returns, but allegedly it was actually making high-risk investments and also engaging in some Ponzi-like schemes to achieve those returns.

Then there is the CEL token. The SEC states:

Since its inception, CEL has played a key role in the company. In a March 2018 white paper, Celsius described CEL as the backbone of Celsius Network. CEL is a token that unlocks discounts and features on the Celsius platform, so the more people want to use the platform, the higher the demand for CEL.

In a live event on March 8, 2018, Mashinsky further explained, "We focus on driving community growth because everything we do is measured by the [CEL] token." Mashinsky went on to say, "As the token price goes up, our entire reward is the token. So as long as this is in the best interest of the community, our job is to do everything we can to increase the token price."

Mashinsky also publicly described the price of CEL as a measure of "Celsius's profitability or operational status." In other words, when Celsius successfully attracts more users, the price of CEL will rise, and when demand for Celsius's investment services declines, the price of CEL will fall.

Consistent with their public statements, Mashinsky and others at Celsius viewed CEL as akin to stock in a publicly traded company. Mashinsky wrote in an internal message that he wanted "to be able to talk about CEL like a public company."

At this point, I agree with Mashinsky: CEL tokens have a somewhat controversial utility (and thus can be seen as commodities); they can perform some functions on the Celsius lending platform, but in reality, they are just stocks of Celsius. When Celsius is doing well, when people have more confidence in Celsius and believe in its future, the price of the tokens will rise; the tokens are a bet on Celsius's business. They are like stocks.

Thus, like any company with publicly traded stock, if Celsius, for example, lies about its business and financial condition, that is securities fraud. Therefore, the SEC cited Mashinsky's statement in an April 2022 CNBC interview, where he claimed Celsius had 1.7 million users, while in reality, there were fewer than 500,000 users. Or in May 2022, Mashinsky tweeted that "Celsius has not suffered any major losses, all funds are safe"; meanwhile, the SEC stated:

On May 9, 2022, just two days before Celsius and Mashinsky posted reassuring statements on Twitter, a Celsius executive referred to the company as a "sinking ship."

On May 12 and 25, the same Celsius executive wrote in Slack communications, "There is no hope… no plan," and that Celsius's business model "is fundamentally flawed."

Another employee bluntly stated in an internal message on May 21, 2022, "We have no profitable services."

Mashinsky knew there were questions about Celsius's ongoing viability. A Celsius executive told Mashinsky in a message on May 25, 2022, "We will continue to be in trouble for months, the asset/liability gap is now more severe, and balances are low."

This is a standard securities fraud case.

Additionally, Celsius allegedly manipulated its price by secretly buying CEL tokens on the open market. There is a strange mechanism here, as there are two ways to buy and sell CEL tokens. The SEC states: "Qualified investors in the U.S. can buy and sell CEL tokens directly from Celsius through the company's over-the-counter (OTC) desk," and if you buy through the OTC desk, due to securities law reasons, your tokens will be locked for a year. But CEL tokens are also listed on various cryptocurrency exchanges. The exchanges are public, while the OTC desk is not, and due to the lock-up period, CEL tokens sold through OTC cannot be immediately traded on the open market. "Because these (OTC) transactions occur on the Celsius platform, they are only reflected in internal records and do not appear on the blockchain or to other users of the Celsius platform."

Thus, there exists a manipulative trading situation:

1. Celsius can sell 1 million tokens OTC at a price of $1 per token.

2. Then, it can use that $1 million to repurchase slightly less than 1 million tokens on the open market, pushing the price up to $1.05 per token.

3. This is bad for Celsius from a corporate finance perspective: it issued more tokens than it repurchased; it sold tokens at a low price and repurchased them at a high price.

4. However, since Celsius's repurchase reduces the supply on the open market and pushes the price up, while its OTC sales do not immediately increase the supply on the open market or push the price down, this results in the effect of manipulating the price of CEL upward.

5. Since Celsius's capital reserves are primarily composed of CEL tokens (which are just created by Celsius), pushing up the price of CEL makes Celsius look larger and more credible and provides it with more financial flexibility: pushing up the price of an asset you control makes you wealthier.

6. Additionally, the next time Celsius sells 1 million tokens OTC, it can sell them at the new market price of $1.05.

According to the SEC, here is how Celsius described its manipulation scheme in an internal memo:

An internal memo listed the "main argument" as raising the price of CEL, stating: "We are intertwined with the rise and fall of CEL," "the more customers use CEL and the higher its value, the more value we can extract from it (for example, using it to pay interest instead of using our cash)."

The internal memo described the plan to raise the price of CEL. The plan included value-based repurchase examples, where Celsius would "repurchase a certain percentage of CEL sold through OTC sales on a case-by-case basis, depending on our cash needs." The memo also detailed a plan to give CEL "value" through increased trading activity by Celsius:

The more we sell CEL through OTC

The more CEL we can repurchase

The more attractive the CEL market becomes

The more CEL buy orders we receive

Ultimately: the more valuable our capital reserves become

The fewer CEL we need to sell, but the value of the funds raised remains the same

This is not entirely a Ponzi scheme, but it is a concerning business plan. It reminds me of Sam Bankman-Fried's explanation of the simplest way to run a cryptocurrency scam, mentioning "the box/black box." You invent a token, own most of the tokens yourself, let some of them trade on a public exchange, and manipulate the price to keep it high. This manipulation will cost you money because you irrationally buy your own tokens at inflated prices to keep the price up, but it will increase the book value of all the tokens you haven't sold, making you look very wealthy on paper. If you try to sell all those tokens to realize wealth, their price will crash------it's just your fictional tokens!------you may end up with nothing. But if you have a large amount of book wealth, you can convert it into actual wealth in other ways, not just by selling it. You can leverage it, or even not leverage it; you just need to say, "Hey, look, I have billions of dollars in assets, you can surely lend me more money."

If your financial reserves consist of billions of dollars in CEL, you can use it as a business foundation. You can use those valuable CEL to pay interest to customers. You can raise cash by selling some CEL with a one-year lock-up. You can attract customers to lend you real money by saying, "Our balance sheet is strong, look at how valuable our assets are." If you have a lot of assets, you can attract more assets. You might be tempted to manipulate the value of your assets.

By the way! Most of the quotes above are from the SEC's complaint, although the Department of Justice, the Commodity Futures Trading Commission, and the Federal Trade Commission also addressed similar content. This mainly reflects my personal bias: I think this is primarily an SEC case because it feels like a very typical securities fraud case to me. Celsius is alleged to have done two things:

It told people "give us your money, and we will invest it for you to earn a risk-free 17% profit," and then lost their money.
It told people "we are an awesome company, buy our stock," but it lied and manipulated the stock price. The first thing is just a typical investment scam; the second thing is a typical low-priced stock promotion and dumping. This is standard practice for the SEC and also applies to the Department of Justice (since the SEC cannot bring criminal charges).

This is my personal view, and clearly the SEC's view as well. But in the cryptocurrency space, many people and some government officials believe that neither of these actions constitutes securities fraud. Cryptocurrency exchanges like Coinbase and Gemini argue that a pooled cryptocurrency lending platform promising interest is not a security. And CEL tokens may not legally be considered securities because they are not actually stocks but utility tokens on the Celsius platform. Moreover, there is an ongoing jurisdictional battle, with the SEC wanting to regulate almost all cryptocurrency tokens as securities, while the cryptocurrency industry wants the SEC to stay away from cryptocurrencies. Therefore, while Celsius may have engaged in serious fraudulent behavior regarding its lending platform and tokens, there remains considerable debate about whether that fraud constitutes securities fraud.

But in the current situation, that doesn't matter! Maybe it's just commodity fraud, but the Commodity Futures Trading Commission (CFTC) is handling that. Maybe it's just general consumer fraud, but the Federal Trade Commission (FTC) is handling that. Maybe it's telecom fraud, but the Department of Justice (DOJ) is handling that. The four U.S. federal regulators have jointly stated, "Whatever fraud you think Celsius is engaged in, we don't like it." Other cases can resolve philosophical and jurisdictional details. But someone will take action against Celsius.

Related tags

Celsius regulation

ChainCatcher reminds readers to view blockchain rationally, enhance risk awareness, and be cautious of various virtual token issuances and speculations. All content on this site is solely market information or related party opinions, and does not constitute any form of investment advice. If you find sensitive information in the content, please click "Report", and we will handle it promptly.