Solvency, and reading a run

Graduate · enrolled learners

This lesson opens with Celsius Network, June to July 2022.

What happened

Celsius was a centralized lender that took customer crypto deposits, paid high yields, and deployed the funds to earn more, much of it in illiquid or leveraged on-chain positions: staked ether that could not be redeemed on demand and traded at a discount, and collateralized loans on protocols like Aave, Compound and Maker where falling prices forced Celsius to keep adding collateral to avoid liquidation: in mid-June it had 18,000 WBTC, about 420 million dollars, in MakerDAO at risk, while the only substantial on-chain liquidity for its staked ether was a Curve pool of about 125,000 ETH that was already heavily unbalanced. Its liabilities, customer deposits, were withdrawable on demand; its assets were not. After the Terra collapse in May 2022 shook confidence, depositors began to run, and Celsius could not turn its illiquid assets into cash fast enough to meet the withdrawals. On 12 June 2022 it froze withdrawals, and on 13 July it filed for Chapter 11 bankruptcy; the filing showed 5.5 billion dollars owed to clients and creditors against 4.3 billion of assets, a hole of about 1.2 billion dollars, after it had repaid its Maker, Aave and Compound loans to reclaim about 1 billion dollars of collateral. Much of the structure, the staked positions, the loans, the scramble to post collateral, was visible on-chain as it happened.

The decision point

Solvency and liquidity are different, and a protocol or lender can be arguably solvent on paper and still fail, because what kills it is the mismatch between when it owes and when it can pay. Celsius owed depositors on demand and held assets it could only sell slowly and at a loss, which is the exact structure of a bank run: as soon as enough depositors doubt they can get out, they all try at once, and the institution cannot liquidate illiquid assets fast enough to satisfy them, so it freezes or fails even if its total assets nominally exceed its liabilities. Reading this on-chain has two parts. Solvency: are the assets worth at least the liabilities, and how liquid are they. The run: are withdrawals accelerating and is the entity being forced to deleverage, sell, repay, post collateral, under pressure. Celsius is the case where both were readable, and the fatal fact was not that its assets were worthless, since it still held 4.3 billion dollars against 5.5 billion owed, but a mismatch between on-demand liabilities and unsellable assets that turned doubt into a run.

Recorded loss

$1,200,000,000

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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