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Not your keys 🔑, not your coin 💰
Plus a butterfly flaps its wings in Terra/Luna
In this issue:
A butterfly flaps its wings in Terra/Luna
Not your keys 🔑, not your coin 💰 (reader submitted)
We are all peasants of the Metaverse
A butterfly flaps its wings in Terra/Luna
Since the last post the price of Bitcoin has plummeted from ~$27k/BTC down to as low as $21k/BTC (a ~22% drop), at time of writing is trading at ~$22k/BTC. Ethereum is also down from ~$1.5k/ETH down to as low as ~$1.1k/ETH (a ~26% drop). That’s especially painful for Ethereum since it represents a fall below the all-time high from the previous cycle (~$1.2k/ETH). Falling below the previous cycle’s all-time high has never happened before for either Bitcoin or Ethereum, though Ethereum has had fewer cycles to test the pattern against.
What’s happening here is not a reassessment of the fundamental prospects of crypto as a technology. Instead what is happening is the institutional equivalent of a liquidation cascade. Terra/Luna overextended and collapsed, which caused Celsius Network to become insolvent (c.f. the story below) so they have been panic selling BTC and ETH to stem the bleeding — dropping the price and perhaps liquidating other firms (like Microstrategy) that have borrowed against their crypto assets.1
Bitcoin mining in particular is a famously tight-margin business done almost exclusively by people who are bullish about the prospects of Bitcoin. It is no wonder that many mining companies borrow against their bitcoin to pay expenses rather than selling. That multiplies profit in bull markets! But it does the same for losses in a bear market. It has been a bad day for Bitcoin mining companies, too.
This is why Bitcoin is so naturally volatile: other people’s losses can multiply together into cascading waves that turn seemingly diamond-handed buyers into forced sellers. A butterfly flaps its wings in Terra/Luna and a series of North American mining companies are suddenly flirting with bankruptcy. That’s why it’s so important to avoid leverage and only buy Bitcoin in quantities you are not afraid to lose. This might seem like a dramatic swing but it is actually still fairly modest by Bitcoin standards.
Not your keys 🔑, not your coin 💰
“I’m looking forward to an article on Celsius networks because I’m finally in the ‘fucked’ pool. 🤬” — BS
I'm so sorry, my friend. 😔
Celsius Network is a centralized lending product that lets users deposit their cryptocurrency and get paid a fixed interest rate. By using the language of "accounts" and "deposits" instead of "unsecured loans" Celsius was able to create the impression with its users that they were putting their money somewhere low-risk, maybe even FDIC insured. The reality was very much the opposite.
The other group sweating bullets are pseudobanks like Celsius that borrowed ETH from users and deposited it into Lido for the staking yield. If users keep withdrawing their ETH before stETH withdrawal is available (which seems to be happening to Celsius) then Celsius will be forced to sell stETH at a significant loss in order to honor customer redemptions … there are reports that users attempting to withdraw have started finding their accounts locked in "HODL Mode."
At the time I thought Celsius had a few weeks of solvency left but in retrospect it was closer to a few hours. As I was writing the post CEO Alex Mashinsky was on Twitter accusing journalists of taking bribes for suggesting they were having liquidity problems. The next morning Celsius froze withdrawals, swaps and transfers for all users accounts, effectively admitting they could no longer pay their debts.
Celsius is a centralized entity so we can’t actually see everything Celsius was doing with user funds but what we can see is pretty revealing. Underneath the hood Celsius was putting user’s money to work in high-risk DeFi strategies and using a subset of the returns to pay the interest it owed users. Users thought they were depositing their money in a savings account that paid a strong interest rate — in reality they were buying casino chips for someone else to gamble with.
One way in which Celsius was irresponsible with its users’ money was that they lost a bunch of it. They lost ~$50M in the BadgerDao front-end exploit. They lost ~$70M in a custody error with Stakehound. It’s unclear how much they lost in the collapse of Terra/Luna but they had at least $500M in UST. All of these bets were placed with user funds. They also used MakerDAO to borrow against users’ funds — they have at least ~24k bitcoin (~$0.5B at time of writing) locked as collateral in a MakerDAO vault. The vault will be liquidated automatically if Bitcoin falls to a price of $16.8k/BTC.2
Another way that Celsius was irresponsible was by assuming most users wouldn’t want to withdraw all at once. A lot of the capital users deposited isn’t lost but it is locked up, either in stETH or staked on ETH2 directly or mining company investments3 or any number of other illiquid investments we will learn about as this unfolds. In theory these assets all have value but in practice that value isn’t accessible in a hurry — so when a bunch of users wanted to withdraw at once (such as during a market-wide crash) Celsius didn’t actually have the cash to honor withdrawals.
In short, Celsius is likely bankrupt and its users are about to get a hard lesson in the difference between depositors and creditors:
The Bitcoin community has a saying that goes back to the fall of Mt. Gox: "Not your keys, not your coin." If you are managing the private keys to your own bitcoin, you own some bitcoin. If someone else is managing the private keys to your bitcoin for you, they own bitcoin. What you own is an I.O.U.4
Other things happening right now:
Here’s a really interesting essay about the medieval conception of land ownership, which involved separating the rights of dominion (right of lordship), disposition (the right to gift or sell) and usufruct (the right of usage). These overlapping and sometimes conflicting rights seem strange compared to our modern conceptions of ownership — but they are a really useful lens for understanding the challenges of ownership and governance for social media platforms and ultimately the Metaverse. We are not the customers of social media companies. We are more like their feudal peasants.
Last week we talked about Coinbase rescinding offers to new hires that hadn’t started yet. This morning they announced layoffs of ~18% of the company, similar numbers to the layoffs already announced by other exchanges. I don’t have any quips here, this is just sad.
Microstrategy itself will probably be fine, their margin call is currently at $3500/BTC and they could continue to post more collateral.
This drop doesn’t have to happen organically. A large institutional trading firm can strategically dump Bitcoin to shove the price down for just long enough to liquidate the vault and collect the collateral. Celsius quite literally has a bounty on its head.
See the link in the story above for a glimpse into how well crypto mining investments are performing right now. 😬
An interesting coda to this story is that competitor Nexo has offered to buy Celsius and bail it out. Don’t be fooled — this isn’t an act of community altruism. Nexo is only offering to buy "qualified assets" and given that Celsius already turned them down earlier this week it seems likely they weren’t offering a super generous price. This is more like a neighbor hearing about your financial troubles and swooping in to buy your home. Even if it ends up happening don’t expect it to automatically make users whole.