What is crypto lending, and why do withdrawals freeze?

On 12 June 2022, the crypto lending platform Celsius Network paused withdrawals. Its customers could no longer move their coins out. A month later the company filed for bankruptcy in New York. In August that year, the Singapore-based lender Hodlnaut halted withdrawals too. The two freezes followed the same pattern, and the pattern comes from how these platforms are built.

What is crypto lending?

Centralised crypto lending is a service in which a company takes customers' coins, and pays them a yield in return. The company then lends those coins on to trading firms, other platforms or borrowers who post collateral. It keeps the difference between what it earns, and what it pays out.

This differs from lending in decentralised finance (DeFi), where a smart contract holds the deposits, and anyone can read its balances on the blockchain. A centralised lender keeps its own books. Customers see a balance in an app, not the loans and positions behind it.

Where does the yield come from?

The yield comes from borrowers. A lender pays depositors out of the interest it charges on loans, and whatever it earns by putting the coins to work elsewhere. A rate well above what the wider market pays tends to mean the lender is taking more risk with the deposits: lending to weaker borrowers, accepting thinner collateral, or moving the coins into riskier strategies.

The depositor carries that risk without seeing it. For the on-chain version of the same question, see our note on DeFi yield (opens in a new tab).

Why do withdrawals freeze?

Withdrawals freeze when a lender cannot return deposits as fast as customers ask for them. The coins are out on loan, or tied up in positions that cannot be unwound quickly. This is a maturity mismatch: deposits can be called on demand, while the loans and strategies paying the yield cannot.

A crypto lender faces the risk of a bank run without the protections built around banks. There is no deposit insurance, and no central bank standing behind it as a lender of last resort. A falling market can push borrowers towards default, and cut the value of their collateral at the same moment.

Customers who notice start to withdraw. That drains the lender's liquid reserve faster, and prompts still more withdrawals. A pause is usually the platform's attempt to stop that spiral before the reserve runs out. It also means every remaining customer is locked in at once.

Who owns the coins once they are deposited?

Often the platform owns them rather than the customer. The answer sits in the terms of use, and it decides what happens in a bankruptcy.

In January 2023, the judge overseeing Celsius' bankruptcy ruled that coins held in its Earn accounts belonged to the company's estate rather than to customers. The court found that the terms customers had accepted transferred ownership of those deposits to Celsius. Earn customers became unsecured creditors, to be paid only after secured, priority and administrative claims. The ruling did not cover Celsius' separate custody accounts, which shows how much turns on the product a customer chose.

The lesson reaches beyond one firm. A balance that earns a yield is usually a balance the platform is allowed to use. A balance the platform can use is a claim on the platform, not coins held for the customer.

How does Singapore treat crypto lending for retail customers?

Singapore restricts it. Under measures published by the Monetary Authority of Singapore (MAS) in July 2023, a licensed digital payment token service provider may not facilitate the lending, or staking of a retail customer's tokens. MAS cited the collapse of crypto lending and staking programmes around the world as evidence of significant harm to consumers.

The same measures require providers to keep customer assets separate from their own. Non-retail customers can still be offered lending and staking, after written risk disclosures that the customer must acknowledge. MAS also states that retail customers are not barred from lending, or staking their own tokens themselves outside a provider's platform.

Rules elsewhere differ. A platform's home regulator and its licence decide which protections apply, if any.

Where Northtape fits

Northtape holds no deposits, and pays no yield. It is a news desk. Stories about frozen withdrawals, halted redemptions and bankruptcy filings are detected by the Risk Radar counterparty lens. For how holding coins differs from using them, see our note on what a crypto custodian does (opens in a new tab).

FAQs

Is a crypto lending balance the same as a bank deposit? No. It usually carries no deposit insurance, and the terms of use may hand ownership of the coins to the platform.

Why did several crypto lenders freeze withdrawals in 2022? Falling prices hit borrowers and collateral just as customers rushed to withdraw. Platforms that had lent deposits out could not return them on demand.

Can a retail customer in Singapore use a lending product on a licensed platform? Not through a licensed digital payment token service provider, which may not facilitate lending of a retail customer's tokens. Retail customers can still lend their own tokens outside such a platform.

What is the difference between lending and custody? A custodian holds coins for their owner, kept separate from its own assets. A lender uses the coins, and the owner takes the risk that they do not come back.

None of this is investment advice. It describes how centralised crypto lending works, not whether any platform, product or yield is suitable or safe.