Crypto Commingling: Celsius Examiner Files Initial Report – Fin Tech

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Shoba Pillay, the examiner appointed in the insolvency of Celsius, filed her interim report on 19 November 2022. Celsius Examiner’s report provides important insights into a crypto exchange’s operational and risk management failures, which can give investors and creditors some insight into what’s going on. To expect in FTX.

The preliminary report provides important insights into Celsius’ financial management and various types of customer accounts. Given Celsius’ management of various accounts and the consolidation of assets between and among them, the examiner explained, “customers now face uncertainty if they have assets that belong to them in the bankruptcy filing.” Her report is extremely detailed and can be accessed here. We highlight some high-level observations from the report below.

  • Earning program. Pursuant to its “earn” program, customers were meant to lend cryptocurrency to Celsius in exchange for certain “rewards” and their principal return. The terms of use, while changing over time, were largely consistent with Celsius ownership of all deposited cryptocurrencies. Each customer’s account reflected the amount of each digital asset (plus rewards) deposited, and Celsius did not have individual wallets with those assets. Instead, when a customer deposits funds they are swept into one or more “master” wallets that aggregate the assets of many customers. Celsius accessed those accounts at its discretion for the purposes of funding many of its investments – which it wanted to generate the desired returns of its clients. When necessary, Celsius executed withdrawals related to the Earn Program by transferring assets from any one or more of its many integrated main wallets to its customers’ external wallets.

  • Care program. The program was launched in April 2022 in response to investigations by various state regulatory authorities. The program is designed to provide a mechanism for the firm to maintain relationships with non-accredited clients in the United States, holding their assets “in custody” without reward benefits. Generally, all deposits from US customers after April 15 go into custodial accounts (and accredited customers can move them into an earning account). The terms of use for escrow accounts are clear – ownership remains with the customer (even if they recognize the risks of bankruptcy). However, the hastily developed, custodial program did not provide clients with individual wallets that segregated assets. Instead, the Company sought to maintain an aggregate level of deposits in the Consolidated Wallets (as expressly permitted by the Terms of Use) that roughly matched the assets in such program. When a customer deposits for the first time, assets are routed to the company’s main wallet, at which point a customer loses the ability to track assets. From the main wallets, assets were periodically, and manually, transferred to custodial wallets. The total amount contained in these joint custodial wallets does not necessarily correspond to the total customer balances allocated to them. At times there was reconciliation. In the event of a shortage, Celsius will transfer coins from a number of sources to custodial wallets to recover the balance. In the days leading up to the filing, liabilities to customers with escrow accounts changed and the value of money held in escrow wallets varied by millions of dollars. As of June 28, the deficit will reach $45 million, the Examiner reportsth. When withdrawing funds to custodial clients, Celsius made transfers not from custodial wallets, but from wallets located at other workstations.

  • Maintain accounts. Celsius was unable to offer custodial accounts to users in nine states due to regulatory issues. For customers in those states, the Company intends to maintain custodial accounts as a temporary substitute. These funds were not available for custodial accounts or the earnings program, and consumers were advised to withdraw them. Unfortunately, customers are unable to withdraw money through the Celsius app but need to contact customer service. In the interim, instead of being treated the same as custodial accounts, the so-called holding accounts’ assets are held in main wallets and are available for use by Celsius as those in the earning program.

Based on the inspector’s preliminary report, Celsius’ ability to match cryptocurrencies deposited by a customer, whether in an earning account, a custodial account or a withdrawal account, appears to be absent shortly after the deposit and the assets are commingled with other borrower assets. For a short time. Certain consumer accounts are tracked by account ledgers, and facts revealed by the examiner’s report may provide additional factual guidance to the bankruptcy court in determining whether account holders can claim their assets were held in trust or “constructive trust.” In other non-crypto bankruptcy cases, whether trust funds can’t be identified or traced after such funds are commingled (sometimes using a technique called the “interim balance rule”) helps determine how much a beneficiary can actually recover. Under this standard, a constructive trust may be imposed if the amount of the joint deposit equals or exceeds the amount entitled to the trust. The examiner’s report provides important factual background for the rapidly approaching trial, the outcome of which will have dramatic consequences for consumers’ ultimate recovery.

Relatedly, while an examiner has not yet been appointed in the FTX case, it is important for FTX to monitor and understand the seriousness of the record keeping and segregation failures and the impact it will have on their account holders and creditors.

The content of this article is intended to provide a general guide to the subject matter. You should seek expert advice on your particular circumstances.

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