While the entire cryptocurrency market has not yet recovered from the Terra crisis, the blockchain community now has to face another threat called Celsius Network.

What is Celsius Network?

Celsius Network (CEL) is a decentralized peer-to-peer (P2P) cryptocurrency lending project, founded in 2017 in the city of London (UK). Accordingly, Celsius allows users to receive interest of up to 18.63% when depositing crypto into the platform, as well as using cryptocurrency as collateral to borrow other coins.

As of August 2021, Celsius Network is considered as one of the giants of the DeFi space with over $20 billion in assets under management (AUM). Not only that, the company's valuation also reached 3.25 billion USD after a funding round of 750 million USD in November 2021.

The fire that lit the fuse

Lido Finance and stETH concepts

Before diving deeper into the developments related to Celsius Network, we first need to understand the root cause of the incident, which revolves around stETH and the Lido Finance (LDO) platform. Basically, Lido Finance is a project that allows users to participate in staking ETH into the protocol to become a validator during Ethereum's upgrade to the Proof-of-Stake consensus mechanism - Ethereum 2.0, also known under the more concise name of The Merge.

In return, users who participate in staking ETH will receive the corresponding amount of stETH from Lido Finance as a tool to secure a 1:1 ratio with the ETH they lock in the platform. After ETH completes The Merge, investors can exchange stETH for ETH.

It will be very simple if investors keep the stETH they are holding.

However, that is not the case. Because investors are now concerned that the ETH price in the market is being severely affected by the general bearish cycle, combined with the potential issue of The Merge continuing to be delayed, there is no guarantee that ETH will retain its value post-merge.

This means that even if stETH is converted at 1:1 ratio to ETH in the future, it will lose more value than the estimated current locked ETH in USD.

For example, if you stake 2 ETH at the price of 1,000 USD each at the moment on Lido Finance, you will get 2 stETH collateral. However, after the successful implementation of The Merge, you can convert 2 stETH back to the original 2 ETH, but in fact the ETH price has decreased to 800 USD, which means you have lost 400 USD.

Therefore, investors need to have an "emergency exit" at the present time. Coincidentally, the Curve Finance protocol has a pool for swapping stETH -> ETH for the above purpose. However, because Curve's pool has a majority liquidity of stETH (79%), and ETH (only 21%), it has led to stETH being de-pegged.

We can see in the illustration below that, instead of a 1:1 ratio, now 1 ETH = 1,051 stETH creates a significant difference, about 5%.

Big funds to start taking action

The reason mentioned above has immediately created quite a significant concern for the well-known venture capital investment funds (VCs) in the cryptocurrency market. Because of the extremely large amount of ETH they bought to participate in staking in Ethereum 2.0, if ETH price continues to drop, especially after The Merge, the loss that VCs have to bear is huge. Therefore, they quickly came up with a solution by “flushing” the stETH back into ETH and then changing ETH to stablecoins like USDT, USDC or BUSD to avoid risks.

The first VC started was none other than Alameda Research - a famous investment fund with close ties to the FTX exchange. According to an update from famous DeFi industry figures on Twitter, on June 8, Alameda Research dumped nearly 50 million USD stETH -> ETH on the Curve Finance protocol, this is also the reason why stETH has been so heavily de-pegged: the excessive liquidity being discharged through ETH caused stETH price to drop sharply.

Even more dangerous is the fact that Alameda Research is just one of 7 VCs participating in staking ETH on Lido Finance. The remaining players, whose names are enough to give the community a huge fright, include a16z, Coinbase, Paradigm, Digital Currency Group (the parent company of the world's largest crypto fund Grayscale), Jump and Three Arrow Capital (3AC). With Alameda Research's move, the community is very concerned that the remaining 6 representatives will continue to release stETH to the market.

The “Death Vortex” of Celsius Network has started

As explained in the beginning, Celsius Network (CEL) is formerly a crypto lending project, so Celsius is required to take users' crypto assets as collateral to stake or lend on many other platforms to make a profit for it to pay 18% APY interest.

In addition, Celsius must ensure that its fund reserves have a large source of liquidity to meet the needs of users to be able to withdraw collateral or deposits any time they want.

This is where the loophole really appears. Celsius's actual ETH liquidity is falling at an alarming rate, only 27% ETH (268,000 ETH) can be withdrawn immediately, the rest is 44% stETH (445,000 ETH) and 29% ETH in staking form, which has to wait at least 1 year to liquidate.

On the other hand, the user withdrawal rate on Celsius is hovering around 50,000 ETH/week. If this frequency is maintained, Celsius will completely run out of ETH to pay users in the next 5 weeks. Also, after learning of this information, many Celsius customers have also continuously withdrawn their BTC and stablecoins from the protocol. In general, Celsius will most likely go bankrupt.

However, instead of choosing the worst solution of defaulting and putting the interests of users first by preserving the remaining assets to compensate them, Celsius gambled with the direction of continuing to pump more liquidity into the platform with the hope that when the market recovers, everything will be settled. In the process, Celsius has also discontinued withdrawals and swaps services for users.

Celsius has used its stETH and WBTC as collateral to borrow on many other lending platforms, including Aave, Compound, and MakerDao. Specifically at Aave, Celsius mortgaged 409,000 sETH, 4,490 WBTC, 34,266 WETH and 750,173 LINK to borrow 203 million USDC, 98.9 million DAI, 930,863 USDT and 54,538 USD REN. The total loan value is 303.61 million USD.

Next is Compound, where Celsius has mortgaged 14,436 WBTC, 87,604 ETH and 13,245 COMP to borrow 135 million DAI and 82.5 million USDC. The total loan value is 217.6 million USD.

Last but not least is MarkerDAO, where Celsius mortgaged 23,962 WBTC and 6.7 million LINK to borrow a total of 228.7 million USD DAI.

The domino effect threatening the entire market

From all of the above, we can be certain that Celsius is the first domino piece to trigger the wave of ETH sell-offs by the VCs and the 3 listed lending platforms.

To clarify this assumption, let's look at the big picture of the current market. There is no denying that the entire crypto industry is in a severe downturn and the declines of Bitcoin (BTC) and Ethereum (ETH) will continue. If both BTC and ETH go down to a very low price point, such as below $20,000 for BTC and $1,000 for ETH, all Celsius loans will be liquidated.

Then, Celsius' liquidated assets will be sold to the market by Aave, Compound and MakerDAO to regain the original loan value. Since Celsius's collateral is primarily stETH, the sale sequence will be as follows: exchange stETH -> ETH on Curve, then change ETH -> stablecoin on a spot market on CEX like Binance or Coinbase.

Combined with the fact that the stETH/ETH pair on Curve is getting even more heavily de-pegged, as it acts as an intermediate circulation bridge, the above discharge will put an enormous pressure on the current ETH price. And when the price of ETH continues to fall, it will lead to VCs realizing the risk of staking ETH on Ethereum 2.0, converting stETH into ETH via Curve and then dumping it on the spot market. Finally, it should be noted that WBTC is also used by Celsius as the second largest collateral besides stETH. When the liquidation occurs, BTC itself is dumped as well. The loop then goes on, leading to a mass collapse.