Alan Knitowski holds an MBA, has worked in technology and finance for over 25 years, and is the CEO of a Nasdaq-traded mobile software company. That didn’t stop him from being scammed by a crypto firm.
Over several years, Knitovsky borrowed $375,000 from the cryptocurrency Celsius and invested $1.5 million. bitcoin as collateral. He didn’t want to sell his bitcoin because he liked it as an investment and believed the price would go up.
It was a Celsius model. Cryptocurrency investors could hold their shares in the firm in exchange for a dollar loan they could use. Knitovsky would get the bitcoin back when he paid off the loan.
But that’s not what happened, as Celsius, which managed $12 billion in assets at the start of the year, collapsed in July after a fall in cryptocurrency prices triggered an industry-wide liquidity crisis. Knitovsky and thousands of other loan holders had more than $812 million in collateral locked up on the platform, and bankruptcy records show Celsius was unable to return collateral to borrowers even after paying off its debts.
“Every aspect of what they did was wrong,” said Knitovsky, who runs an Austin, Texas-based company. Phunware, – he said in an interview. “If my CFO or I had actually done something that looked like this, we would have been charged immediately.”
Lenders are now going through the bankruptcy process to get back at least some of their funds. They were given a measure of optimism on Friday after Celsius announced the sale of its asset custodial platform, GK8, to Galaxy Digital.
David Adler, a bankruptcy attorney at McCarter & English, who represents Celsius creditors, said the money from the transaction should go toward paying legal fees. In addition, there may be funds left over for past customers.
“The big question is – who is entitled to the money they received from GK8?” Adler told CNBC. Adler said he represents a group of 75 borrowers with about $100 million in digital assets on the Celsius platform.
More relief may come later this month, as Celsius’ loan portfolio will be tendered. If another company buys the loans, customers will likely have a chance to pay them back and then release their liens.
Knitovsky told CNBC that he chose to buy his loans with a 25% loan-to-value ratio. This means that if he had taken out a loan of $25,000, he would have pledged four times that amount, or $100,000.
The more collateral the borrower is willing to post, the lower the interest rate on the loan. If the borrower defaults on the loan, the lender can seize the collateral and sell it to cover its value. It is like a residential mortgage where the borrower uses the house as collateral. In the cryptocurrency world, a borrower can request a loan and pledge bitcoin as collateral.
Earlier this year, as the price of bitcoin fell, Knitovsky paid off one of his Celsi loans to avoid being called on margin and having to increase his collateral. But after doing so, the company did not return the bitcoin that served as collateral for that loan. Instead, the assets were deposited into an account named “Gazan”. According to the company’s terms and conditions, the assets in those accounts are the property of Celsi, not the customers.
“Imagine you’re paying off your car, but someone’s holding it,” Knitowski said. “You pay off your house, but someone keeps it. In that case, it’s like you paid off the loan. And in return, even though it’s paid off, you don’t get your mortgage back.”
Not to disclose
That was not the only problem. The cryptocurrency failed to provide full federal Lending Act (TILA) disclosure to borrowers, according to a July 4 email to former employees and customers. The act is a consumer protection measure that requires lenders to provide critical information to borrowers. , such as the annual percentage rate (APR), the term of the loan, and the total cost to the borrower.
“The disclosures required to be provided to you under the Truth in Lending Act do not include one or more of the following,” the email to borrowers said, and then went on to list more than a dozen possible missing disclosures.
A former Celsius employee, who spoke on condition of anonymity, told CNBC that the company tried to retroactively comply with TILA.
“You can’t say, ‘Oh, wow, we forgot about 25 points in the Truth in Lending Act, and eventually we’re going to redo them and pray,'” Knitowski said.
Crypto.news editor and author Jefferson Nunn took out a loan with Celsius and posted more than $8,000 worth of bitcoins as collateral. He knows that even if he repays the loan, these assets are now unavailable to him.
Nunn, who lives in Dallas, said he got a loan to invest in more bitcoin after seeing the platform’s promotion. He said he heard about Celsi after a podcast with co-founder Nuke Goldstein. On the show, Goldstein said “your money is safe,” Nunn said. Alex Mashinsky, the former CEO of Celsius, made similar comments shortly before the withdrawal.
Alex Mashinsky, CEO of Celsius on stage in Lisbon for Web Summit 2021
Piaras Ó Midheach | Sports File | Getty Images
“It’s basically a mess and my funds are still locked up there,” Nunn said.
This topic has come up many times in cryptocurrency, most recently with the failure of FTX. The founder and CEO of the exchange, Sam Bankman-Fried, told his followers on Twitter that the company’s assets are good. A day later, it was looking for a bailout during a liquidity crisis.
While Celsius’s implosion has not had the magnitude of FTX, which was recently valued at $32 billion, the company’s management has faced its share of criticism. Senior executives withdrew millions of dollars in assets before the company stopped withdrawing customer funds, according to a court filing in October.
A former employee, who did not want to be named, said the lack of financial controls led to significant gaps in the company’s balance sheet. One of the biggest problems was that Celsius had a synthetic short, which occurs when a company’s assets and liabilities don’t match.
A former employee told CNBC that when customers made cryptocurrency deposits with Celsius, it had to ensure those funds were available when the customer wanted to withdraw them. However, Celsius was taking customer deposits and lending to risky platforms, so it did not have the liquidity to repay the required funds.
As a result, when clients wanted to withdraw their funds, Celsi struggled to buy assets on the open market, often at a premium.
“It was a huge error in judgment and operational control that really hurt the balance sheet of the organization,” the former employee said.
He also said Celsius was hoarding worthless cryptocurrency tokens as collateral. Celsius announced on its platform that customers can “earn compound cryptocurrencies in BTC, ETH and 40+ other cryptocurrencies.” But according to a former employee, the teams responsible for deploying these coins had nowhere to go with more obscure tokens.
The former employee said he left Celsi after discovering the company was not being careful with customer funds and was making risky bets to keep up with the high returns it promised depositors.
“Many individuals have pulled all their money out of traditional banking systems and put their full faith in Alex Mashinsky,” he said. “And now those people can’t pay for medical bills, they can’t pay for a wedding, they can’t pay for a mortgage, they can’t pay for a pension, and it’s very hard on me and my colleagues who are leaving the organization.”
Celsius did not respond to multiple requests for comment. Mashinski, who resigned from Selsey in September, declined to comment.