Last Friday, the stETH liquidation panic caused by the serious tilt of the Ethereum 2.0 pledge protocol Lido pledge pool aroused the market’s fear of the UST decoupling event, and ETH fell 7% for three consecutive days, falling below $1,500 and hitting a 15-week low , All kinds of FUD are frequently circulated in the community, what is going on? How should investors interpret it? This article is derived from the long analysis article “Staking, pegging and other stuff” by Twitter KOL Cobie, organized and compiled by the editorial department of the dynamic area. (Recap:How serious is the risk of stETH when institutions withdraw from Lido and sell off?) (event background:Ethereum hits a 15-month low” U.S. CPI unexpectedly hits a 40-year high! BTC falls below 28k, below $1,500)
Before I begin, I would like to state that this is an opinion piece written in a hurry, and I have not proofread it; so I apologize in advance for the large number of errors that may appear in it.
First, I am not qualified to make investment advice, so none of the following constitutes financial or investment advice.These are my thoughts, not my employer’s – maybe I’m also lacking the qualifications
Also, I did assist Lido before, contributing a little bit early on in the project, which is one of the themes in this article. But I haven’t worked for Lido anymore in over a year, which also means I’m not writing this on Lido’s behalf, and I haven’t even taken the time to show this to anyone who works at Lido — mostly because if they I found some errors in this article, and I don’t want to spend time changing this article.
Lastly – I own some LDO, some ETH, and some stETH, so I’m also probably very biased, and I have a bad idea about the issue that could even be thrown away. I do try to be as unbiased as possible, because you win when you find the right answer, not shouting the wrong answer over and over on the internet.
Cobie, wait a minute, what is a Lido?
Here’s my October 2020 introductory article on what Lido was supposed to be like: Introducing Lido
Simply put, it is a collaborative protocol for ETH staking. is a staking pool with a tokenized version of the ETH you stake.
You stake 1 ETH and Lido will give you 1 stETH in return. Your ETH will be staked in a set of node operators chosen by Lido, one of the validators. As that ETH earns staking rewards, your stETH balance will automatically change to match that beacon chain balance.
After the ETH developers finally release The Merge and the subsequent fork, stETH will be able to “Unstake” and the ETH in the pledge will also be redeemable.
Lido has become very popular because Ethereum designed their staking mechanism a bit oddly, and although the Beacon Chain launched at the end of 2020, there is still no specific merger date. For users, this is the most popular way to stake ETH.
Got it? OK then!
stETH peg (Peg)?
For most of its product cycle, the stETH to ETH trade ratio was close enough to 1:1.
Although very volatile and very volatile in the first few months of stETH’s life cycle, the price of each stETH varies from 0.92 to 1.02 ETH. But as liquidity increases, the stETH/ETH pair becomes more and more boring (stable) over time.
Then came the UST decoupling event, and with Luna crashing, stETH took some contagious hits. Since then, the price of ethereum has fallen by about 50% — in fact, nearly ten weekly bars on ethereum are in the red.
Perhaps because it is a historically similar trading pair (and perhaps because “pegging” is a recent hot topic in post-traumatic syndrome after the UST incident), people mistakenly view stETH as being “pegged” to ETH. Of course, this is not true.
In fact, stETH is not pegged to ETH, nor does Lido (or stETH) require a 1:1 transaction ratio with ETH to function properly. The market price of trading stETH is based on (or not at all) the “demand/liquidity” of the ETH in the pledge.
Lido is not the only liquid staking protocol. Looking at other lesser-used and less liquid collateral derivatives, it’s almost impossible to see a 1:1 liquid collateral market:
These two staking derivatives work similarly to Lido. Ankr launched a little earlier than Lido, and Binance’s BETH launched a few months later, but they launched around the same time.
As you can see, in their product cycle, they have basically never traded at the “pegged” price. BETH fell to 0.85 ETH per BETH; AEHC fell to 0.80 ETH.
Collateralized derivatives are not stablecoins, they are not even “algorithmic stable”.
Some would describe them as more like Greyscale’s GBTC, or as a futures market with an unknown delivery date.
I don’t know if the analogy is right, but fundamentally it’s tokenized ownership of locked collateral, which should trade at a lower price than the underlying asset it’s locked in.
ETH in Redemption, Arbitrage, and Pricing Staking
You can instantly create 1 stETH with 1 ETH by staking on Lido. Therefore, stETH should never trade above 1 ETH.
If stETH was trading at 1.10 ETH, traders could easily mint 1 stETH for 1 ETH and sell it for 1.10 ETH – they can repeat this to easily arbitrage until the premium recovers.
However, such instant arbitrage opportunities do not exist in the opposite direction.
Users will not be able to redeem Ethereum liquid staking tokens (stETH, BETH, RETH, AETHC… etc.) until after the Ethereum merger, and after eth2 enables transactions.
Current claims about when the merger will take place are all speculation. If I had to guess, I’d probably say October of this year, but that’s also likely to be pushed back to the end of this year or early next year. And even after the merger of Ethereum, it still needs to wait for the fork of the state transition to redeem. Who knows how long this will take, maybe 6 months after the merger.
Of course, there is a limit to the amount of ETH that can be unstakes at one time. If all staked ETH is unstaken at the same time, the unstaking sequence is likely to take more than a year.
If the above processes are completed, there will be arbitrage opportunities in both directions for liquid staking tokens. A trader can buy 1 stETH for 0.9 ETH, exchange it for 1 ETH, and repeat.
However, the price of liquid collateral tokens could still fall below 1:1 when this arbitrage route is opened, and not during a happy bull market. The fair price will likely depend on how much profit and risk the buyer wants to take during the redemption/unstaking period – during which the seller will weigh the impact of waiting for the unstaking period against the discount to sell immediately .
Currently, this “lack of redemption path” situation has resulted in a liquidity discount.
In a bull market, the demand for ETH is high. Buying stETH at a small discount is attractive because traders can see buying stETH for less than 1 ETH as a way to get extra ETH. In addition, the demand for liquidity in a bull market is also lower, as investors are happy to hold their rate-raising assets, and there is less selling pressure on stETH.
However, in a bear market, the demand for ETH disappears and the hunger for liquidity quickly becomes apparent. Long-term demand for these often highly reflexive assets has fallen particularly sharply. More and more people want to exit their staked ETH positions, which makes long-term locked assets less attractive than short-term ETH positions.
The tETH-to-ETH discount will depend on how much liquidity existing stETH holders need, and the need to buy this collateralized ETH derivative at the discount. What’s more, some larger players are constantly expressing their liquidity needs for stETH in order to redeem their stETH positions.
— Hsaka (@HsakaTrades) June 10, 2022
Of course, there are other factors as well. The discount can come from: smart contract risk, governance risk, beacon chain risk, “will the merger happen?”… Price anchoring risks. While these risks are more of a “constant quantity” to the variables of buyer/seller demand, the way people assess their importance may change as market fears change.
Macro liquidity preference still appears to be the biggest variable, but so far the general sentiment towards the merger has had little impact.
Macro liquidity preference still appears to be the biggest variable, while market sentiment towards the merger has so far been more of a non-correlated factor.
forced sale seller
Probably because of post-traumatic stress disorder (PTSD) after the UST event, a lot of people focus on the price of stETH, but I think stETH, the symptoms pointed to may be a completely different story.
Perhaps the most compelling stETH discussion right now is: Who are the forced sellers?
There seem to be several groups now:
Leveraged Stakers Entities that require processing deposit redemptions
The first group can be identified through on-chain data.
Traders can use Aave to “leverage” ETH. Such a transaction looks like this:
Buy ETH Stake ETH as stETH (or buy stETH on the market) Deposit new stETH into Aave Use this deposit as collateral and lend ETH Stake borrowed ETH as stETH Repeat this
Products like Instadapp (and others) turn this trading strategy into a “Vault,” attracting massive deposits into leveraged stETH positions.
Unless traders can provide more collateral for these positions, they have an on-chain liquidation price. At the same time, to deleverage the position, it will be necessary to sell stETH to ETH, which also indirectly affects the pricing of stETH.
If ETH continues to fall, triggering the liquidation price of these positions, it will lead to forced liquidation, and these forced selling of stETH will further trigger a sharp drop in the price of stETH, causing more positions to trigger the liquidation price to be forced Close the position.
CeFi Deposit Withdrawal
Regarding the second group, individuals who need to process deposit redemptions, the situation is a bit more opaque.
Brick-and-mortar companies like Celsius have so-called liquidity problems, as stated in some rumors and on-chain research. Of course, since Celsius is a “CeFi” company, we have no way of really understanding their financial health or financial management strategy.
So these kinds of rumors are entirely speculative, and we can’t really know what’s going on inside Celsius.
However, the researchers speculate that users are currently withdrawing faster than the liquid funds held by Celsius.
50k ETH/week, Celsius will run out of liquid ETH in around 5 weeks.
It is impossible for Celsius to honor redemptions after that without realizing massive losses due to stETH’s illiquidity. Eventually, they will be forced to gate all redemptions.
Not looking good.
— yieldchad (@yieldchad) June 5, 2022
The issue is that @CelsiusNetwork is quickly running out of liquid funds to pay back their investors who are redeeming positions.
Billions in illiquid positions that they are taking massive loans against to payout their customer redemptions. https://t.co/jnjuWe8qhs
— Small Cap Scientist 👨🔬🧪🥼 (@SmallCapScience) June 10, 2022
There is also speculation that Celsius is losing money on DeFi. Celsius is rumored to be affected by losses at StakeHound, Badger, and possibly the Luna/UST event.
It started with a $70M loss in a StakeHound Exploit… https://t.co/1BmWyIE0rx
— Small Cap Scientist 👨🔬🧪🥼 (@SmallCapScience) June 10, 2022
The research narrative appears to be expressing:
Celsius allegedly used users’ deposits to earn yields on DeFi’s yield farms, in return for providing user interest. They likely lost funds in this exploit.
In addition, they staked a large amount of ETH (both using Lido and directly with illiquid staking node operators). This pledged ETH is illiquid, it may last 6 months, it may be just over a year.
For Celsius, even liquid staking is illiquid because their position size is larger than the liquidity available on stETH.
To this end, Celsius will become a forced seller of stETH (sell stETH) if it wants to restore liquidity for user withdrawals, which may trigger a liquidation waterfall. In fact, even just fear of the event, becoming can be a trigger.
Again, this is speculative. We don’t know Celsius’ actual financial position, what tools do they have at their disposal? What customer liabilities do they have…etc.
While it seems unlikely that Celsius would completely lose customer funds, it seems theoretically possible that Celsius would have to face a user requesting a withdrawal; however, Celsius has locked these assets on the beacon chain, and the unlock date is constantly moving into the future extension.
How Celsius handles such hypothetical situations may matter. If they borrow against those pledged assets to repay customers, it may just delay their forced liquidation and end up making things worse.
So, who gets hurt?
I’m not going to pretend that I can predict what will happen to the price of stETH (or BETH, AETHC, RETH, etc.) in the future.
Instead, I’ll try to understand who’s going to suffer in the worst-case scenario: imagine the fud on Celsius is true, and on-chain leveraged stakers can’t add collateral…etc.
Who are the victims?
Celsius and depositors at Celsius would obviously suffer – either by not being able to process withdrawals for everyone after the merger, or by the way Celsius ended up selling for a low price, processing withdrawals before the merger, and taking huge losses as a result.
(Note: If I were in a position like Celsius, I would probably sell stETH in the OTC market (over the counter) at a considerable discount to save face and maintain public confidence.)
Pledgers of leveraged yield mining will obviously also suffer if their positions are also liquidated.
Anyone who wants to get out of their stETH positions before the beacon chain state transition will also be uncomfortable: if a trader or investor stakes ETH today (or buys “discounted” stETH today) and needs to do so within 3 weeks or 3 Out of the market within a month, it obviously does not guarantee that the price of stETH/ETH will be the same as when they entered.
Those stETH holders who are not using leverage and plan to unstake on the beacon chain will be fine, as each stETH has a 1:1 counterpart to ETH on the beacon chain.
1:1 Redemption, is it guaranteed?
1 stETH, 1 BETH, 1 AETHC…etc can be exchanged for 1 ETH when Ethereum is merged and can be unstakes. So, if you have 10 stETH today, when the Ethereum developers finally do something, you will get 10 ETH back.
And yet—what could cause these things to happen? The two main factors are as follows:
Slashing – If you have 10 stETH today and the Lido validator encounters some slashing, then the loss will be shared among stETH holders. The ETH corresponding to stETH will increase through rewards, and may also decrease rewards due to cuts. In the event of a similar slash event, 10 stETH could turn into 9.5 ETH. I think it’s the same for Ankr. Only RocketPool results may vary due to requiring additional collateral from validators. Critical Protocol Bugs – If there is a critical bug in Lido, RocketPool, Ankr or any other protocol, then this could also have an impact on the redemption of their liquid collateral tokens.
Both of these scenarios are possible, as always happens in the market. But on the beacon chain, slashing is rare, and I think most liquid staking protocols have well-planned validators.
Of course, the protocol has also been extensively audited – but I am sure that the severe post-traumatic stress syndrome (PTSD) caused by the audited but also occurred DeFi protocol thunderstorm caused you and I to have lingering fears.
While these are very real risks (one minor, one more serious), both are unlikely in my opinion – and their risks have not increased or decreased over time.
There are also smaller risks, such as Eth2 delivery risk (will the merger happen, will it happen soon?) and governance risk. But again, they didn’t increase or decrease substantially.
(Note – if ETH2 is never delivered, what will happen to the ETH in pledge? It may need to be recovered in some way through social consensus. Because liquid staking derivatives only account for about 1/3 of all ETH pledged, and Every cryptocurrency service provider and exchange has access to ETH staking in some way. This is going to be a bigger problem than just staking tokens)
In any case, in addition to these risks, 1 “liquid staking ETH” from any liquid staking protocol will be redeemable for 1 ETH when Ethereum can unstake, regardless of the market rate of stETH/ETH at that time.
Incoming state transitions
For those willing to accept the risk of smart contracts and validators, this situation presents an interesting opportunity: How long are traders willing to hold stETH to redeem arbitrage? At what price will they step in?
Arbitrage may become more attractive as the day of “mergers and state transitions” on the beacon chain gets closer. Perceived price risk is likely to be less as redemption times get shorter – but it will still largely depend on traders’ market sentiment towards USD prices.
Well, I’m too lazy to write. I’m going to play League of Legends. If anything is unclear, I will reply in the comments. I may also not reply, depending on how I feel after losing this LOL Clash tournament.
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