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Will Nexo be the next lending platform to collapse?

Zhuorui Fu

2022-12-08 11:00

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One of the three major CeFi platforms has gone bankrupt and liquidated, leaving only Nexo with assets worth $2 billion. After FTX's collapse, the storm cloud extended to multiple platforms, including Genesis and BlockFi, which are in urgent need of help. Celsius, one of the three major CeFi platforms, has already gone bankrupt and liquidated in the previous Luna collapse. Since 2022, the market value of Nexo's token NEXO has evaporated by 80%.

There are gradually people questioning Nexo's liquidity on Twitter. Looking at Nexo's Twitter before the end of November, most of the comments were voices of doubt from Twitter users or customer service demands from Nexo platform users, reflecting certain technical loopholes. The Nexo token continued to decline in the seven days before December 1st, and has seen a significant increase since December 1st, with the latest report showing a 9.16% increase. In recent days, there is no Nexo available for lending or short selling on Binance.

In order to fight against short selling, Nexo released a long string of profit models and multiple tweets explaining its operation mode and various financial terms on Twitter on November 29th, reiterating that it has no exposure in BlockFi and Genesis, does not provide unsecured loans, and does not have the asset-liability mismatch that users questioned about the other two major CeFi platforms. It also emphasized that it will launch reserve proof. Its auditor, the US company Armanino, also released an audit report, which investigated Nexo's wallet address, clarified the platform's assets, and understood the platform's liabilities through API, and issued an audit opinion stating that Nexo's US dollar assets are worth more than its liabilities. On November 30th, Nexo announced that it had obtained relevant licenses in Italy and can provide financial services in Italy, promoting its entry into the first-tier market. One day later, Nexo announced its support for Pancake.

Despite the overall market downturn, Nexo is still expanding aggressively. In May, they submitted a letter of intent to purchase Celsius' assets in Zug, and in June, they acquired Vauld, a struggling lending platform established by Peter Thiel and Coinbase Ventures. Despite the collapse of two major CeFi platforms, Nexo is still expanding its products and hiring personnel.

This series of actions seems to be telling users that Nexo has abundant assets and liquidity, and the company is full of energy in its development. But is this really the case?

Binance no longer offers NEXO for borrowing

Enter Nexo - Is Buying a Banking License Reliable? Legal Doesn't Necessarily Mean Useful

Nexo states on its official website that it is a digital asset platform, and its parent company, Webinfo, is registered at Grafenaustrasse 15 in Zug, Switzerland. The state is known for its lenient tax policies and concentration of cryptocurrency companies, so it is not surprising. However, Nexo does not have a banking license in Switzerland. According to information from the website nexo.how, which is not directly affiliated with Nexo, Nexo is powered by Credissimo, a FinTech company established in Bulgaria in 2007 that focuses on providing financial lending services. Nexo aims to tap into the $4 trillion cryptocurrency lending market. Nexo was established in Bulgaria in 2018 but later moved to Zug. The nationalities of Nexo's founders, Antoni Trenchev, Kosta Kantchev, and Kalin Metodiev, are unknown, but based on their LinkedIn histories, all three have grown up or worked for companies related to Bulgaria, with Kalin Metodiev being the chairman of the Bulgarian CFA Association and Kosta Kantchev being the founder of Credissimo.

Nexo has a wide range of businesses and has acquired banks in the United States, with no shortage of users in the country. Currently, Nexo has currency transfer licenses in several states, including Arizona, Alabama, and Kansas, allowing it to legally operate financial services. It also has lending licenses in states such as Oklahoma, New Hampshire, and Wyoming, allowing it to conduct borrowing and lending operations. However, having the right to operate financial services does not mean that funds are insured by the government. In September 2022, Nexo acquired Hulett Bancorp, a federally regulated bank in Wyoming, which owns Summit National Bank, a member of the Federal Deposit Insurance Corporation (FDIC) with four branches in Wyoming, Idaho, and Montana. Nexo stated that this investment can expand its business in the United States, but the specific business situation is unknown. Nevertheless, a few months later, on December 6, Nexo announced that it would gradually stop its products and services in the United States in the coming months. In September, Nexo was sued by eight states in the United States (inheritance management lawsuit), claiming that its interest-bearing products should be registered as securities. Nexo blamed these regulators for its strategic turn in the United States, stating that the regulatory conditions in the United States are still immature and unclear, even though cryptocurrency regulation in the United States is already considered a gray area in many countries and regions.

If, within a few months after the United States leaves, most of the licenses listed on the Nexo official website are from the United States, what identity will Nexo use to carry out financial services in the future?

Nexo's license in Switzerland is "SO-FIT" in the canton of Geneva, a non-profit organization that practices self-regulation under the supervision of the Swiss Financial Market Supervisory Authority (FINMA). Members participating in SO-FIT are required to voluntarily uphold industry standards, use qualified auditors, and combat money laundering and financial crimes. Currently, a series of industry standards are being called for, but the consequences of violating them are unclear.

In the overall weak compliance of the encryption industry, Nexo has always been proud of its compliance in external publicity. The various financial-related operational licenses collected by Nexo in the United States can also prove its strategy and execution methods of providing financial services as legally as possible. However, this compliance only represents operational compliance and does not guarantee asset protection. Previously, BlockFi, which went bankrupt, also pointed out in the disclaimer that BIA is not a bank and will not be protected by regulation. The rhetoric also expressed that BlockFi is very "compliant", but still cannot escape the fate of bankruptcy.

As a lending institution, Nexo is very proud of the collateral it receives for its loans. Nexo refuses to issue leverage without collateral or with insufficient collateral assets. Its lending has always focused on automated collateral credit, and it automatically liquidates user collateral when the LTV exceeds the danger value (automatic liquidation is also controversial and involves collateral ownership). Nexo currently accepts collateral for 60+ cryptocurrencies and offers 40+ fiat currency options. Nexo also supports the most cryptocurrencies and fiat currencies among the three major CeFi platforms of the past. The LTV for Bitcoin and Ethereum is 50%, and the LTV for Nexo's token NEXO is 15%. However, Nexo stated on Twitter that it has "never" used NEXO as collateral and does not lend NEXO. Therefore, Nexo explained that the existence of NEXO is similar to that of BNB, as an ecological token that can provide the best experience for platform users.

Screenshot of the supported currencies section on the Nexo official website, with NEXO on the right.

Users holding NEXO tokens on the official website of Nexo can participate in the Nexo Earn Product project and receive at least 1NEXO per day, with a maximum APY of 12% and daily compound interest. This product is not available to users in Bulgaria, Estonia, or the United States (which is also worth pondering). Previously, Celsius had participated in high-risk projects several times in order to ensure such a high APR, resulting in heavy losses. BlockFi even misappropriated user funds for its own mining services, which ultimately led to a mismatch between asset value and debt due to the decline in asset value.

In order to participate in normal financial operations, it is not uncommon for CeFi lending to have a license, but the "compliance" of the license depends on self-awareness. Even in the United States before the 2008 financial crisis, due to the government's regulatory lag, the growth of shadow banks and subprime loans could not be stopped, although banks were all "acting in accordance with the law" before the crisis. Therefore, a license can only prove the legality of operation, not the rationality of private company's operation, especially when most of Nexo's licenses still rely on self-regulation.

Nexo's business model, sourced from the Nexo official website

Insurance and Platform - Is Real-time Audit Reliable?

As Nexo itself does not have a banking license, it is not a custodian bank, and the assets stored in Nexo are all held by third-party custodian platforms. Nexo has $775 million in insurance from BitGo, Ledger, bakkt, Fireblocks and other cryptocurrency service providers, which are underwritten by Lloyds Bank and Marsh & Arch in London. Previously, Ledger was involved in a hacking scandal in 2020, where user data was leaked, and Ledger stated that it would not compensate users but would instead work to strengthen financial security. In the traditional mutual fund industry, if a mutual fund company goes bankrupt, the custodian bank will return the assets held in custody to shareholders. In the cryptocurrency industry, it is unclear whether the risk is "micro-pru" or "macro-pru". It is also unclear whether the custodial funds are in the form of volatile cryptocurrencies or already converted into fiat currency.

In addition, Armanino provides real-time PoR audits. As of the publication date, Nexo has a debt of 154,634 bitcoins, and the company's books are over-collateralized with no other information. Armanino is an independent company under Moore North America, and independent companies operate independently, and membership does not represent direct cooperation. Armanino provides audit reports for multiple cryptocurrency companies and publishes real-time asset changes for clients through its real-time searchable window TrustExplorer. Users can see the real-time changes in the dollar value of assets and liabilities on the website. Armanino is also a partner of the stablecoin TrueCurrencies, providing real-time audits of TrueUSD, TrueHKD, and other currencies.

Armanino's real-time audit screenshot

Real-time PoR cannot prove the liquidity of a company's assets, nor can it prove whether the company actually has that many assets. The existence of PoR seems to have given users a peace of mind, but the effectiveness of this peace of mind may not be scientifically reasonable. The author previously wrote an article analyzing stablecoin audits titled "What can we observe from the five-year audit report of USDT?". Except for algorithmic stablecoins, major stablecoins usually release monthly or real-time PoR audit reports to prove the value of their book assets. However, except for Tether, other fiat stablecoin companies have not disclosed details of their US dollar assets. Tether's books show that most of its assets are highly liquid US bonds, cash, etc., and investment-grade corporate bonds and other metal and electronic asset investments account for only a small portion. This ensures that Tether can quickly mobilize liquidity and confirm its financial solvency in the event of a run. The undisclosed US dollar value of other companies may even be real estate. Although the US dollar value is still significant and can still cover the debt on the books, real estate has extremely poor liquidity compared to US bonds and cash. Once a run occurs, the company will face a liquidity squeeze and can only borrow or declare bankruptcy. During the 2008 financial crisis, banks did not lack sufficient assets, but in the case of the collapse of subprime mortgages, the assets held by banks were mortgage properties, not highly liquid assets. The same can be applied to cryptocurrencies, where the liquidity of asset classification cannot be proven. This is evident in the FTX bankruptcy case, where many of FTX's assets were illiquid FTT, which led to FTT being sold off during a run and a vicious cycle of liquidity squeeze.

Currently, according to the loan-to-value ratios of various currencies published on the Nexo website, cryptocurrencies with higher liquidity are more likely to be used as collateral for loans.

In addition, Armanino's real-time information is a screenshot of the amount in the user's account taken at regular intervals. However, if the company supplements the user's account balance through borrowing when Armanino takes the screenshot, Armanino will still publish a PoR visible on the website to prove that the company has the necessary assets, regardless of how the assets are recorded.

Summary: Not afraid of no asset, afraid of illiquid asset class

Nexo's executives have decades of experience in hard finance and fintech backgrounds, with licensed operations, so they should be experienced in avoiding common liquidity risks in financial history. Nexo's series of licenses and occasional tweets clarifying risks and exposures on Twitter also indicate Nexo's external risk control stance.

According to Nexo's Twitter post, the company has been "lucky" to avoid being hit by multiple defaults, and in an article published on November 28th, the company reiterated that it will not lend to previously defaulted companies or mining farms, nor will it provide unsecured loans to cryptocurrency asset managers. Traditional banks conduct sensitivity tests after the 2008 financial crisis to test their ability to withstand pressure during bank runs. Nexo claims to have an internal system that tests the short-term liquidation of collateral in extreme situations, and has not lost a dollar so far.

Maybe Nexo is right, but given the current opaqueness of the documents, there is a lot of room for imagination about the capital misappropriation, operation, and investment behind CeFi lending. Nexo did not have institutional clients default this time, but that does not mean it won't happen next time. Perhaps there have already been institutional clients defaulting, but Nexo has ensured asset and liability matching through asset misappropriation on the books. In addition to the extreme volatility of cryptocurrencies, if the next wave of cryptocurrency depreciation occurs and the platform faces a large-scale run, Nexo's current evidence is not specific enough to prove its true ability to withstand extreme risks. This situation is similar to banks holding real estate in 2008. If there is no large-scale run and real estate prices fall, banks will not suffer from a short-term liquidity crisis, which could trigger systemic risks. Previously, Luna, Celsius, FTX, etc., if not shorted or run on in the short term, are likely to avoid short-term liquidity crises and avoid bankruptcy.

It is unknown what specific actions Nexo has taken to ensure the asset value on the audit report, and whether the collapse of Celsius and BlockFi was due to ethical reasons or the difficulty of controlling risk in the cryptocurrency lending industry.

Before Celsius went bankrupt, it was involved in the "Ponzi" model, attracting new users with high interest rates and using the savings of new users to reward the interest of old users. After the FTX aftermath, Nexo still frequently launches new high-interest and convenient products, including the new Mastercard launched a day ago, which has no minimum monthly repayment and offers a maximum APR of 13.9%, giving back to users who use Bitcoin and NEXO, and is currently only available to EU citizens. When a company is healthy, launching financial products that are convenient for retail investors can increase the utilization of funds and financial inclusiveness, and improve user experience. However, when a company is unhealthy, it may be a Ponzi scheme.

It is a coincidence that, prior to the Three Arrows bankruptcy incident, when Celsius went bankrupt, Nexo immediately came out and said that it had no assets on Celsius and had nothing to do with Three Arrows. On June 15th, Nexo tweeted that it had not agreed to provide 3AC with unsecured loans in the past two years. Prior to this, Nexo and Three Arrows signed a cooperation contract in December 2021 to jointly develop an NFT fund. However, Three Arrows went bankrupt too quickly, and Nexo stated that this project had not had time to develop, so when Three Arrows went bankrupt in June, Nexo had no contact with Three Arrows.

Currently, Nexo's expansion may indeed be a confident move to fill the gap in CeFi, but it is also possible that it is a false show to cover up internal problems that have already arisen.

The former leader of Sanjian Qian Palm, Zhu Su, who did not obtain a loan, recently retweeted a tweet from Zyplag questioning the risks of Nexo, seeming to imply something.

In addition, Nexo has made a major strategic shift in the United States, and has recently been involved in scandals and actions, including the recent transfer of 5,000 WBTC from MakerDAO to Wintermute, the transfer of 15,498 ETH, of which 9,413 went to Binance, and being sued by investors on November 22 for allegedly freezing investor funds...

Although Nexo has its own explanations for the above news, its various actions are somewhat confusing.

Due to the lack of regulation in the cryptocurrency industry, users who suffer financial losses can only bear the consequences themselves without any means of appeal. If Nexo goes bankrupt, US users can seek legal protection through the bankruptcy court within the validity period, which has become one of the few means of user protection in cryptocurrency bankruptcy cases and is a channel for appeals. Users in other regions are on their own. Although borrowing can increase the utilization of funds, users should also be cautious, as this is only applicable when your collateral is secured.

Reference

https://nexo.io/licenses-and-registrations

https://static1.squarespace.com/static/629566eddf761c0fd6ff930b/t/6385b5628671157ecf115ab8/1669707108984/2022-11-29-6385b209b781a94a1b238e8f.pdf

https://www.theblockbeats.info/news/31508?search=1

https://support.nexo.io/s/article/earn-daily-interest-up-to-12-apy-on-your-nexo-tokens

https://www.armaninollp.com/press-releases/armanino-elects-record-24-new-partners-in-2022/

https://real-time-attest.trustexplorer.io/nexo

https://www.theblockbeats.info/news/31162?search=1

https://blockworks.co/news/what-are-proof-of-reserves-and-can-they-build-back-trust

https://nexo.io/media-center/nexo-upscales-its-eu-wide-licensing-with-new-registration-in-italy?utm_source=twitter&utm_medium=post&utm_campaign=twitter_post_italian_license_3011_q422