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It has been more than a week since Celsius shut its doors to withdrawals, but still no time has been given for when customers will be able to get their money back, if ever.
With all user funds still trapped within the platform, a growing number of Celsius customers have been pondering as to whether the courts might help them and to what extent.
Last week, as reported by VIXIO, crypto influencer and YouTuber Ben Armstrong, better known as BitBoy Crypto, announced plans to lead a class action lawsuit against Celsius.
He alleged that Celsius and CEO Alex Mashinsky had lied about the safety of user funds, and could therefore be charged with fraud and be made to pay out damages to investors.
On Saturday (June 18), however, Armstrong announced that he and his legal team have decided to scrap the class action lawsuit, after admitting that Celsius’ Terms of Use (to which Armstrong agreed) would make it extremely difficult to win the case.
“Even in the long-shot scenario where it’s successful, attorneys would make most of the money,” he said.
“Users would receive very little compensation, and it would most likely take many years.”
Armstrong also realised that his former relationship with Celsius as a promoter of the platform would clash with his role as the lead plaintiff and could be considered a conflict of interest.
Since his original announcement of the class action suit, others in the crypto industry have mocked Armstrong for attempting to sue Celsius for a “grift” that he himself participated in and profited from.
Armstrong responded by saying that very few people in the industry, including himself, foresaw Celsius’ liquidity issues.
He added that he was a user of the platform: “I wasn't telling people to use something I didn't use. I was using it because we trusted it.”
All in all, Armstrong claims to have made about $3,000 from his Celsius affiliate link programme, whereby he would get paid a commission per user he referred to Celsius.
This pales in comparison to the $2.97m that Armstrong claims he is “currently down” following crypto’s most recent slide, and due to his funds being locked into Celsius.
The trouble with bankruptcy
Like other Celsius customers, Armstrong’s hopes for redress are now shifting towards bankruptcy proceedings, but that too is hardly a panacea.
Adam Levitin, commercial law professor at Georgetown University, has said that although a Celsius bankruptcy would be a landmark case for crypto, it is unlikely to satisfy investors who have suffered losses due to the Celsius lockup.
According to Levitin, Celsius users broadly fall into two categories: those who have used the Earn feature; and those who have used the Custody feature.
The Custody feature was only added to the platform in April this year, and is only available to US users. This means that the vast majority of Celsius users globally are Earn users.
Earn is where Celsius users put their crypto-assets if they wish to get paid interest on them. By doing so, this effectively means that these customers have extended loans to Celsius on the expectation of repayment of principal plus interest.
In the event of bankruptcy, Levitin said that these customers will be seen as unsecured creditors.
“Unsecured creditors will recover a prorated share of whatever assets are left after (1) all secured creditors have been paid, and (2) all of the administrative costs of the bankruptcy have been paid (e.g. lawyers and financial advisors),” he said. “It’s not a happy place to be.”
Custody-only customers are in a slightly stronger position as they are not “creditors” to Celsius, and may be able to argue that they had full legal ownership of their crypto-assets for the whole time that they were on the Celsius platform.
“If the Custody wallet customers ‘own’ their crypto, they would have dibs on the Custody assets (divided pro rata among them), but only to the extent those assets exist,” said Levitin.
“So if Celsius was dipping into Custody wallets to cover its own obligations and the funds are gone, then they're screwed.”
Although not suggesting that this is what Celsius has been doing, Levitin said this practice is common among distressed businesses fighting bankruptcy.
Who owns what?
The question as to which crypto investors can be considered unsecured creditors was explored by Levitin in a research paper published last month.
Although US law gives substantial protection to the custodial holdings of securities, commodities and cash deposits held by brokers and banks, Levitin said no such regime exists for crypto-assets.
“Instead, bankruptcy courts might well deem the custodial holdings to be property of the bankrupt exchange, rather than of its customers,” he wrote.
“If so, the customers would merely be general unsecured creditors of the exchange, entitled only to a pro rata distribution of the exchange’s residual assets.”
In a conclusion that now seems prescient, Levitin wrote that credit risk from the passive holding of crypto-assets has been overlooked, both by regulators and by crypto investors alike.
“Because this passive holding risk turns on technical details of bankruptcy and commercial law, it is unlikely to be understood, much less priced, by most market participants,” he said.
“The result is a moral hazard in which exchanges are incentivised to engage in even riskier behaviour because they capture all of the rewards, while the costs are externalised on their customers.”
In the case of Celsius, all of its customers have all agreed to a deeply one-sided Terms of Use, which states explicitly, in Section 13, that in the event of bankruptcy users may not be able to exercise rights of ownership over their assets.
“In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations,” reads clause 3 of Section 13, “any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws”.
