Alan Knitowski has an MBA, has been in technology and finance for over 25 years and is the CEO of a Nasdaq-listed mobile software company. That didn’t stop him from being duped by a crypto firm.
Knitowski borrowed $375,000 from crypto lender Celsius over several years and pledged $1.5 million in 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.
related investment news
In a post-FTX world, crypto investors need to know three things, according to financial advisors
That was the Celsius model. Cryptocurrency investors could essentially store their holdings with the firm in exchange for a dollar loan that they could use. Knitowski would get the bitcoin back when he repaid the loan.
But that didn’t happen as Celsius, which managed $12 billion in assets earlier in the year, filed for bankruptcy in July after a plunge in crypto prices caused an industry-wide liquidity crisis. Knitowski and thousands of other borrowers had more than $812 million in collateral on the platform, and bankruptcy records show that Celsius did not return collateral to borrowers even after repaying their loans.
“Every aspect of what they did was wrong,” Knitowski, who runs an Austin, Texas-based company called Phunware, said in an interview. “If my CFO or I had actually done what appeared to be the case, we would be charged immediately.”
Creditors are now working through the bankruptcy process to try to recover at least some of their funds. They were provided with a degree of optimism on Friday after Celsius announced the sale of its asset custody platform, dubbed GK8, to Galaxy Digital.
David Adler, a bankruptcy attorney at McCarter & English representing Celsius’ creditors, said the money from the transaction must be used to pay legal fees. In addition, funds could still be left for former customers.
“The big question is — who is entitled to the money they get from GK8?” Adler told Health & Fitness Journal. Adler said he represents a group of 75 borrowers who have about $100 million worth of digital assets on Celsius’s platform.
There could be more relief later this month as the tender for Celsius’ loan portfolio opens. If another company buys the loans, customers would likely have an option to repay them and then release their collateral.
Knitowski told Health & Fitness Journal he decided to take out his loans at a 25% loan-to-value ratio. That is, if he took out a $25,000 loan, he would deposit four times that amount as collateral, which is $100,000.
The more collateral a borrower is willing to post, the lower the interest rate on the loan. If the borrower fails to repay the loan, the lender can seize and sell the collateral to recoup the cost. It’s like a residential mortgage where the borrower uses the home as collateral. In the crypto world, a borrower can apply for a loan and pledge bitcoin as collateral.
Earlier this year, when the price of bitcoin fell, Knitowski repaid one of his Celsius loans to avoid taking margin calls and having to increase his collateral. But after that, the company didn’t return the bitcoin that served as collateral for that loan. Instead, the fortune was deposited into an account called Earn. According to company terms and conditions, assets in these accounts are owned by Celsius, not customers.
“Imagine paying off your car but someone keeps it,” Knitowski said. “You pay off your house, but someone keeps it. In this case, it would be like paying off the loan. And instead you don’t get your collateral back even though it’s paid off.”
That wasn’t the only problem. The crypto platform has also failed to provide borrowers with full Federal Truth in Lending Act (TILA) disclosures, according to former employees and an email sent to customers on July 4. The law is a consumer protection measure that requires lenders to provide borrowers with important information such as the annual percentage rate of charge (APR), the length of the loan and the total cost to the borrower.
The email to borrowers stated, “The disclosures required to be provided to you under federal truth in lending law contained none or more of the following,” and then listed more than a dozen possible missing disclosures on.
A former Celsius employee, who asked to remain anonymous, told Health & Fitness Journal that the company is retrospectively trying to comply with TILA.
“You can’t say, ‘Oh, oops, we forgot about 25 points in the Lending Truth Act, and so we’re just going to repeat them and pray,'” Knitowski said.
Jefferson Nunn, an editor and contributor to Crypto.news, took out a loan from Celsius and pledged more than $8,000 worth of bitcoin as collateral. He knows that even if he repays his loan, those assets will no longer be available to him.
Nunn, who lives in Dallas, said he got the loan to invest in more bitcoin after seeing a promotion for the platform. He said he heard about Celsius after doing a podcast with co-founder Nuke Goldstein. On the show, Goldstein said, “Your money is safe,” Nunn said. Alex Mashinsky, former CEO of Celsius, made similar comments just before halting withdrawals.
Alex Mashinsky, CEO of Celsius, on stage at Web Summit 2021 in Lisbon
Piaras Ó Midheach | Sports File | Getty Images
“It’s basically a mess and my funds are still locked in there,” Nunn said.
This topic has come up repeatedly in crypto, most recently with the failure of FTX last month. Sam Bankman-Fried, the exchange’s founder and CEO, told his followers on Twitter that the company’s assets are fine. A day later he was looking for a bailout amid a liquidity crisis.
While Celsius’ implosion isn’t on the scale of FTX, which was recently valued at $32 billion, company leadership has faced its fair share of criticism. According to a court filing in October, top executives withdrew millions of dollars in assets before the company stopped withdrawing client funds.
A former employee, who declined to be named, said there was a lack of financial oversight that left the company with significant holes in its balance sheet. One of the biggest problems was that Celsius had a synthetic short, which occurs when a company’s assets and liabilities do not match.
The former employee told Health & Fitness Journal that when customers deposit crypto assets with Celsius, one should ensure that those funds are available whenever a customer wants to withdraw them. However, Celsius took customer deposits and then lent them to risky platforms, so it didn’t have the liquidity to return funds on demand.
Therefore, when customers wanted to withdraw funds, Celsius would seek to buy assets on the open market, often at a premium, the person said.
“It was a huge error of judgment and operational control that really took a toll on the organization’s balance sheet,” said the former employee.
He also said that Celsius is accumulating cryptocurrency tokens that have no value as collateral. On its platform, Celsius announced that customers could “earn compound crypto rewards using BTC, ETH and over 40 other cryptocurrencies.” But according to the former employee, the teams responsible for staking these coins weren’t familiar with many of the more obscure tokens.
The former employee said he left Celsius after discovering the company was not being prudent with client funds and was making risky bets to continue earning the high returns it promised depositors.
“Many individuals have taken all their money out of traditional banking systems and put their complete trust in Alex Mashinsky,” the person said. “And now these individuals are unable to pay medical bills, weddings, mortgages and pensions, and that continues to weigh heavily on me and my colleagues who have left the organization.”
Celsius did not respond to multiple requests for comment. Mashinsky, who resigned from Celsius in September, declined to comment.