A litany of speculation has trailed Celsius Network‘s announcement that it is pausing all withdrawal, swaps and transfer between accounts.
The existing lack of transparency and accountability that surround many crypto projects often pushes financially insolvent projects like Celsius to attempt to trade its way out of insolvency.
But what is insolvency? And what is Celsius Network’s actual status in this regard? Read on to find out!
What is Insolvency?
Insolvency is a financial condition in which an entity is unable to pay its debts. It may result in insolvency actions when a judicial process is initiated against the insolvent entity, and assets may be liquidated to pay off outstanding obligations.
Types of Insolvency:
Cash-Flow Insolvency
This is where a company cannot pay its debts as they become due. That is, you simply have more outgoings than you can sustain.
Balance-sheet insolvency
This happens when the company’s liabilities exceed its assets.
In simpler terms, cash-flow insolvency does not mean you do not have the assets to meet these outflows; however, timing matters in this case.
Putting Things in Perspective
Imagine you locked your net worth of $10,000 in a fixed deposit with a bank, say 28 days tenor. However, an associate shows up and asks you to repay a $2,000 loan within a few days. In this instance, you cannot pay up this loan, and so you are insolvent!
Cash-flow insolvency could result in balance sheet insolvency. This isn’t terrible because if a firm must cease operations because it cannot pay its debts as they become due. The carrying value of its assets may need to be reduced to its forced sale value rather than their going concern value.
In our example above, you cannot pay your friend $2,000 now. However, give it some time and you’ll be able to repay the loan – and maybe another $100 for his inconvenience.
In the worst-case scenario, you can break the $10,000 fixed deposit today. Incurring a percentage penalty, but allowing you to pay off the $2,000 loan.
How Does all this Relate to Celsius?
With Celsius Network, the cessation of withdrawals and transfers is undoubtedly a tactic to buy time until sufficient assets become liquid again.
If Celsius Network’s insolvency is related to cash-flow, there is no cause for concern, and there is light at the end of the tunnel for investors.
However, if they are relating to balance sheet insolvency, there is cause for concern. As explained in our example above, this would mean Celsius Network do not have sufficient assets to cover the outstanding requests.
So, as opposed to having $10,000 locked in a fixed deposit and owing $2,000. You have a net worth of $10,000 (in a fixed deposit), but you owe $50,000.
In this situation, creditors are in a precarious position.
Trading Out of Insolvency
Commonly, the phrase “trading out of insolvency” describes the process through which a business experiences a severe cash flow difficulty it has little chance of recovering from.
When a company is insolvent, the interests of its management no longer match those of its creditors. Each dollar you lose would have gone to your creditors, yet each dollar you earn brings you closer to financial recovery.
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With that being the case, why wouldn’t you put all you have left on a high-risk bet. Knowing that if you lose, your creditors will suffer, but if you win, you’ll be able to escape your present situation with a profit? Like risking $10,000 to win $100,000 to avert the imminent liquidation?
It is easy for debt to spin out of control when there is disruption in cash flow for whatever reason. Business owners and directors who are confident in the core business values but want a little respite to restore a solid financial footing may trade out of insolvency.
This behavior attracts heavy penalties/liabilities on an individual under wrongful trading/fraudulent trading laws, which states that if you are a director (or controller) of an insolvent company and then start trading, you could be personally liable.
Final Thoughts
In the crypto space, anything can happen.
It is important that Celsius Network openly explains its current insolvency position, as well as detailing the actions and steps it hopes to take to recover from the looming crash.
We hope this piece has given an insight into what Celsius Network insolvency means. To fully understand what is going on with Celsius Network, read our full analysis here.
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