CoinMarketCap Alexandria dives into the stETH situation, from what caused the deviation from ETH price, to what impact it could potentially bring to the crypto market.
This article aims to answer the following questions:
- What is stETH?
- How does stETH work?
- Why is stETH de-pegging?
- Why is the de-peg a big deal?
- Who is caught in the crossfire?
What Is stETH?
$stETH is a tokenized form of staked Ether native to Lido Finance, a decentralized liquid staking service provider for Ethereum, Solana, Kusama, Polkadot and Polygon. Once Ethereum migrates away from proof-of-work (PoW) and the Merge, slated to happen in Q3/Q4 2022, is complete, the mainnet merges with the Beacon Chain.
However, if you want to gain exposure to the proof-of-stake (PoS) staking yields today, you can buy stETH, which is backed 1:1 by ETH deposits on the Beacon Chain.
1 $stETH is redeemable for 1 $ETH on the Beacon Chain.
However, withdrawals will only be possible after the Capella hardfork, estimated to be around 6 months after the Ethereum Merge.
If you have stETH and want to convert it back to ETH now, you have to swap it on the open market. Although stETH and ETH have historically traded close to 1:1, they have different demand — with stETH mainly from people wanting to leverage their holdings.
Therefore, it is important to note that stETH is not pegged to ETH.
What Caused stETH To Deviate from Ethereum?
stETH works like a zero-coupon bond for ETH. 1 ETH today is more than 1 ETH in 2023 because of staking rewards. It's more like an IOU backed by $ETH.
As stETH is is just illiquid ETH, it makes sense to trade at a discount. By buying stETH, you are essentially giving your ETH in exchange for stETH and rewards in the form of yield.
In terms of demand, stETH is mostly used as collateral to borrow more stETH, essentially leveraging your position.
It is important to note that stETH and UST are not the same. stETH is redeemable 1:1 for ETH in the bank (Lido) that will be redeemed after the Merge. On the other hand, UST can be redeemed by LUNA but if there is no demand for LUNA, UST goes to 0.
This all seems good — however, the problem comes when stETH is used as collateral, in a market where asset prices are going down a slippery slope.
What happens if we use illiquid assets as collateral?
Why Is the De-peg a Big Deal?
Say you have: 10 stETH at $2k per 1 ETH. You get a loan of $14k at 70% LTV (loan-to-value).
ETH goes down 20% to $1.6k. stETH holders panic and sell stETH on a CEX.
Suddenly 1stETH = 0.95 ETH,
Now your collateral is only worth $15.2k and not $16k! This makes a big difference if stETH is a big part of your collateral.
Now, imagine you are a lender and have assets and liabilities.
Assets: stETH (100%)
Liabilities: customer deposits in ETH (100%)
ETH tanks 20%. Your customers want their ETH but you only have stETH! Now what?
You sell your stETH.
One place to do that is the stETH:ETH Curve pool.
It's a two-sided pool that pairs stETH with ETH. When all the ETH is drained, there is no one to sell to. Your stETH is technically worthless. It's an illiquid asset with no buyers.
Who Is Caught in the Crossfire?
Customers withdraw money because they are worried Celsius cannot pay.
Celsius has assets but no liquidity. So they sell stETH and become a forced seller, thereby causing stETH to deviate even further.
Celsius also has its stETH locked up as collateral elsewhere. So it could get margin-called if stETH declines too much in value. That's why they halt customer withdrawals and try to deposit more collateral.
Three Arrows Capital (3AC)
3AC is a hedge fund. In short, they use stETH as collateral for loans.
If stETH trades at a too big discount, they have to deposit more collateral or their position gets liquidated.
It seems like that is exactly what is happening.
If these funds/lenders become insolvent, they are forced to sell their assets. Prices could tank even more. That could trigger more margin calls elsewhere, extending the already brutal crypto market meltdown.