Celsius and the Case for True DeFi

The implosion of Celsius, 3 Arrows Capital, and other digital asset lending platforms was a case study in the power of DeFi, a fully transparent financial system

Following the implosion of Luna/Terra in May, the reported insolvency at Celsius marks the second large-scale consumer crypto project to face potential failure. After freezing client assets, Celsius has hired a restructuring law firm to advise on possible solutions.

As of May 2022, Celsius managed ~$11bn of client funds, down from $25bn in December 2021. Celsius offered up to 18% annual yields on crypto deposits, with marketing efforts focused on retail investors. Celsius claimed to investors that they would use “DeFi” strategies to generate outsized yields on money deposited with them. However, they reportedly acted like an unregulated hedge fund with client capital, making risky loans and trading with leverage.

Regulatory Impact

Long term we believe this gives the SEC significant leverage in their push to regulate the digital asset markets. The SEC has previously targeted crypto lenders such as BlockFi, who paid a record-setting $100mm fine to the SEC earlier this year.

SEC Chairman Gary Gensler recently commented broadly on crypto lending platforms:

"We've seen again that lending platforms are operating a little like banks. They're saying to investors 'Give us your crypto. We'll give you a big return 7% or 4.5% return.' How does somebody offer (such large percentage of returns) in the market today and not give a lot of disclosure? I caution the public. If it seems too good to be true, it just may well be too good to be true."

Our view is that a clear regulatory framework from the SEC will be a key unlock for DeFi’s potential. It’s challenging today for a talented, experienced founder to commit to building a DeFi project knowing that the SEC could ruin their business model with new regulation. Our hope is that this regulation focuses on protecting consumers from bad or dishonest actors, not on "true DeFi" protocols such as Aave and Uniswap.

Celsius vs. "True DeFi"

While Celsius called itself a DeFi company, they operated like a traditional off-chain financial entity with humans making the lending and borrowing decisions. As a Celsius customer, you deposit your funds with Celsius and “trust” they are making smart decisions with these funds. You have no transparency into where your funds are or the types of bets Celsius is making.

DeFi’s mission is to create a “trustless” financial system. DeFi protocols such as Aave use smart contracts to create a set of rules around how digital assets can be lent or borrowed. Lending and borrowing interest rates are set by the computer program based on the supply and demand from users for that specific asset. Borrowers must maintain a certain collateral level on the app or their position will be liquidated. Every transaction is recorded on the blockchain and funds can be easily traced. Barring an error with the smart contract code, it is impossible for a Celsius-like situation to happen with Aave.

While this episode makes a clear case for regulation in the crypto markets, it also highlights the potential power of a trustless financial system.

Understanding Risk

In an asset class with highly asymmetric growth potential and elevated volatility, the number one priority of any digital asset investor must be effective risk management. This does not mean to not take risks, but instead to focus on deeply understanding the risks you are taking.

The inefficiencies and volatility in the digital asset market presents opportunities to generate returns not possible in traditional finance. In the case of Luna and Celsius, the 18-20% yields themselves were not the problem. The problem was the obfuscation to retail investors of the risks being taken to consistently achieve those yields.


Oath Digital, Inc. All content is original and has been researched and produced by Oath Digital, Inc (“Oath Digital”) unless otherwise stated herein.  This report is for informational purposes only and does not constitute an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. There is not enough information contained in this report to make an investment decision and any information contained herein should not be used as a basis for this purpose. This report does not constitute a recommendation or take into account the particular investment objectives, financial situations, or needs of investors. Investors are not to construe the contents of this report as legal, tax or investment advice, and should consult their own advisors concerning an investment in digital assets. The price and value of assets referred to in this research and the income from them may fluctuate. Past performance is not indicative of the future performance of any assets referred to herein. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments.

Certain of the statements contained herein may be statements of future expectations and other forward-looking statements that are based on Oath’s views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. In addition to statements that are forward-looking by reason of context, the words “may, will, should, could, can, expects, plans, intends, anticipates, believes, estimates, predicts, potential, projected, or continue” and similar expressions identify forward-looking statements. Oath assumes no obligation to update any forward-looking statements contained herein and you should not place undue reliance on such statements, which speak only as of the date hereof. Although Oath has taken reasonable care to ensure that the information contained herein is accurate, no representation or warranty (including liability towards third parties), expressed or implied, is made by Oath as to its accuracy, reliability or completeness. You should not make any investment decisions based on these estimates and forward-looking statements.

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