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Customers of crypto lender Celsius face a long and anxious wait to know how, when and even if they will get their money back after the company filed for bankruptcy, becoming one of the biggest victims of the collapse in crypto markets this year.

Citing extreme market conditions, Celsius froze withdrawals in June in a move that reverberated through the crypto world and beyond, spurring a US$300-billion selloff in digital assets and leaving legions of retail investors cut off from their savings.

Celsius Network, which is based in the U.S. state of New Jersey, revealed a gaping $1.2-billion hole in its balance sheet when it filed for Chapter 11 bankruptcy in New York this week.

Canadian pension and investment giant Caisse de dépot et placement du Québec is among the large financial institutions vulnerable to losing its investment in the troubled company. The Caisse bought into Celsius as part of a US$400-million funding round that valued the company at about US$3-billion late last year.

Customers should now buckle up for a bumpy ride as they await some clarity over the fate of their money, six lawyers specializing in bankruptcies, restructuring or crypto told Reuters.

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With scant precedent for bankruptcies at large crypto companies, the prospect of multiple lawsuits against Celsius, as well as the high complexity of any restructuring, the Chapter 11 process is likely to be slow, the lawyers said.

“This could last for years,” said Daniel Gwen at Ropes & Grey law firm in New York. “It’s highly likely there’s going to be a lot of litigation.”

Celsius did not reply to requests for comment.

Crypto lenders boomed during the pandemic, attracting retail customers with double-digit rates rarely offered by traditional banks, in return for their crypto asset deposits.

On the flip side, institutional investors such as hedge funds paid lenders higher rates to borrow the coins, leaving firms such as Celsius to profit from the difference. Lenders also invested in riskier, so-called decentralized finance markets.

When crypto markets slumped this year as surging inflation rates sparked a flight to safer assets and two major tokens – terraUSD and luna – failed, the riskier bets by lenders on wholesale crypto markets turned sour.

U.S. crypto lender Voyager Digital filed for bankruptcy this month too after suspending withdrawals and deposits, while smaller Singapore lender Vauld and Hong Kong-based Babel Finance have also frozen withdrawals.

Chapter 11 bankruptcies allow companies to prepare turnaround plans while remaining operational.

While major crypto firms have failed before, most notably the Japanese exchange Mt. Gox in 2014, there is little precedent for the treatment of customers at stricken crypto lenders, the lawyers said.

“It is, at best, unknown how the bankruptcy code and bankruptcy courts will be treating cryptocurrency companies,” said James Van Horn, partner at Barnes & Thornburg in Washington.

Creditor committees formed as part of bankruptcy proceedings will likely seek to shape any reorganization plan decided by Celsius, three lawyers said. Creditors can also make claims against the company even as it goes through the process.

“It’s probably going to take, given the complexity, six months, at a minimum, just to develop a plan to come out of bankruptcy,” said Stephen Gannon, partner at Davis Wright Tremaine. “This is going to be three-dimensional chess.”

In general, Chapter 11 bankruptcies prioritize repayments to secured creditors, then unsecured creditors, and then equity holders.

“(Unsecured creditors) have no earmarked rights to any funds or anything, everything’s been commingled,” Mr. Van Horn said. “Sometimes it’s a very small amount that unsecured creditors get.”

Celsius said in court filings this week that it had more than 100,000 creditors.

As of July 13, it had some 23,000 outstanding loans to retail borrowers worth US$411-million, backed by crypto collateral worth US$766-million, it said in a filing on Thursday.

While Celsius listed its largest 50 creditors, it made no mention of the order in which they would be repaid and many of its 1.7 million clients are individual investors.

One of them is Martin Jabou, 27, who lives in Hamilton. He put crypto assets worth about $45,000 into Celsius, though they are now worth less than half of that.

“I think we’re going to be last on the list,” he said of any repayments from the bankruptcy. “I don’t know how to afford rent or car payments, especially with the other debts that I have.”

Crypto lenders such as Celsius acted in a similar way to banks. But unlike for mainstream lenders, there is no safety net for people such as Mr. Jabou when crypto platforms fail.

At U.S. banks, deposits of up to US$250,000 are insured by a federal body. Broker-dealer clients are insured for up to US$500,000 in securities and cash by a separate body.

Similar deposit protection schemes exist in the European Union and Britain.

While it is not clear how Celsius will classify its clients, it did warn customers it may treat them as unsecured creditors – and customers are likely to litigate over such a status, said Max Dilendorf, a lawyer in New York specializing in crypto.

“It will be a one-of-a-kind case to see why customers should be classified as unsecured creditors,” he said.

- With a file from The Globe and Mail

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