The past several days have seen one of the most brutal selloffs in recent crypto history, as many major cryptocurrencies broke big support levels amidst general market panic and macroeconomic fears. Given the speed of this selloff, several crypto banks and exchanges have halted withdrawals, locking users out of their funds in this critical time.
Since these delays are costing real users significant sums of money due to being unable to sell at key times, we want to dig into what happened and demonstrate how thoughtful regulation could have better-protected consumers, now and in the future.
What Happened at Binance?
Binance suspended native Bitcoin withdrawals for several hours yesterday. The stated reason was that withdrawals had exceeded the amount of BTC that was in their hot wallet. When they went to transfer more BTC from their cold to hot wallets, they likely entered too low of a priority fee, causing the transaction to become stuck behind newer transactions with a higher fee. They could not update the priority fee because nobody had the seed phrase for this wallet for security reasons.
After the Bitcoin network calmed down, Binance’s transaction went through and withdrawals were re-enabled for users within a couple of hours. These are actually generally good security practices, as you generally don’t want to keep too many funds in the hot wallet in the event of a hack or unforeseen breach. In short, Binance’s paused withdrawals were akin to a mini-bank run on the hot wallet only. That said, centralized exchanges clearly need a better contingency plan for these situations, as the amount of downtime was unacceptable for users who needed to modify their position.
While this was undoubtedly harmful to end-users who were unable to sell their coins during a period of high volatility, this is the better scenario compared to the sh*t show that happened at Celsius over the past few days.
What Happened at Celsius?
In short: Celsius was using user funds to engage in DeFi activities in order to earn the yield they paid to users. Due to the intense market crash, these positions were in danger and not able to be easily exited due to the use of stETH, a derivative based on locked Ethereum staking. When the market crashed, they decided to freeze user withdrawals, which allowed them to post user funds as collateral on DeFi platforms to secure their large borrowing positions.
This Twitter thread breaks it down well:
These users’ funds are still actively at risk of being liquidated. The violent price action yesterday was due to whales and market makers hunting for Celsius’ liquidation point in an attempt to liquidate user funds. These players use their massive holdings to throw their weight around to make a quick buck at the expense of everyday users.
Not Your Keys, Not Your Crypto
The main sentiment we’ve seen on social media in response to these events was pretty expected:
Not your keys; not your crypto.
As soon as you deposit your coins into a centralized platform like Celsius or Binance, you are giving up explicit control of your coins based on whatever the ToS of that platform happens to dictate. This means that crypto banks and exchanges can yield farm with your assets or do all manner of risky things like Celsius was doing.
One also needs to consider what happens in the event of bankruptcy (which Celsius may be facing shortly). A couple of months ago, Coinbase caught heat for stating in an investor call that, in the event of a bankruptcy, user deposits could be used to pay back Coinbase’s debts before returning leftover funds back to users. What will happen to Celsius’ user funds in the now-somewhat-likely event of bankruptcy? (Not to mention the funds that are actively at risk of liquidation in DeFi borrowing positions)
Self-Custody Isn’t for Everyone
We understand the promise of crypto to “be your own bank.” But, frankly, a lot of people can’t be trusted to manage their own social media passwords, let alone their private key worth thousands of dollars. If crypto is ever going to go mainstream and be the basis for a future financial system, it has to be much more foolproof than it currently is. Especially given that blockchains are irreversible; if your 70-year-old grandparent clicks one wrong button – *poof* – life savings are gone forever.
Like it or not, centralized platforms like Celsius offer a great solution for less technical users who still want access to crypto. Celsius was seen as a fairly safe way to introduce friends and family to the space. It was a (seemingly) reputable entity that made it easy to set up an account and participate in DeFi without having to understand the complexities of a wallet and managing your own security. How many friends and family members are now at risk of losing everything?
Regulation *Might* be Helpful
Look, we know most users in this space are pretty anti-regulation. Most hardcore crypto users will go the self-custody route and insist everybody else do the same. But, as we mentioned above, this simply isn’t tenable for most users as adoption increases. We need to regulate the centralized entities and ensure that they are responsibly managing user funds.
The recent Responsible Financial Innovation Act draft actually had multiple clauses that would have helped address and prevent a situation like this from occurring. For example:
- Full disclosure about the use of deposited customer funds.
- Minimum uptime requirements.
- Requirements that users be paid out first in the event of bankruptcy.
- Minimum reserve requirements.
We’re not saying that the draft bill is perfect (or that it stands a good chance of being passed), but these are the sort of talking points we need to reiterate to lawmakers in order to eventually get the right legislation passed.
When the bill is formally released, we will send out a call-to-action with talking points on the Responsible Financial Innovation Act to make sure that consumer protections are put in place for this kind of centralized service offering. Sign up to be notified when we send out the call:
Responsible Financial Innovation Act