The latest involves the Lido stETH deviate problem after Terra UST and Celsius Network. As news of crypto projects failing one after another keeps coming in, the bear market is almost at its most terrifying point. The latest involves the Lido stETH problem after Terra UST and Celsius Network. Let us discuss why stETH deviated from ethereum and how will it affect the broader crypto market after its deviation.
What is stETH?
Lido Finance, a decentralised liquid staking service provider for Ethereum, Solana, Kusama, Polkadot, and Polygon, offers a tokenized version of staked Ether called $stETH. The mainnet combines with the Beacon Chain once Ethereum transitions away from proof-of-work (PoW) and the Merge, which is expected to happen in Q3/Q4 2022, is finished.
However, you can purchase stETH, which is backed 1:1 by ETH deposits on the Beacon Chain, if you wish to get exposure to the proof-of-stake (PoS) staking payouts right now. The Beacon Chain allows for the exchange of 1 $stETH for 1 $ETH.
Withdrawals won’t be feasible until the Capella hardfork, which is anticipated to occur about six months after the Ethereum Merge. You must exchange it on the open market if you have stETH and wish to change it back to ETH right away. Although traditionally stETH and ETH have traded at almost a 1:1 ratio, their demand is distinct, with stETH being primarily used by investors looking to leverage their holdings.
Therefore, it’s crucial to understand that stETH is independent of ETH.
What Made stETH Deviate from Ethereum?
The cryptocurrency market evaporated as people preferred liquid assets to illiquid ones as the crypto market collapsed and LUNA/UST crashed. As a result, the liquid ETH in Curve Finance’s stETH:ETH pool was drawn down by more than 80%. The selling pressure on stETH increases due to the market dump of stETH by whales like Celsius Network and 3AC to meet margin requirements. Like a zero-coupon bond for ETH, stETH functions. Staking profits mean that 1 ETH today is worth more than 1 ETH in 2023. It resembles an IOU supported by $ETH more.
Trading at a discount makes sense because stETH is basically illiquid ETH. You are essentially exchanging your ETH for stETH and incentives in the form of yield when you purchase stETH. Demand-wise, StETH is typically used as security to borrow more StETH, effectively hedging your position. It’s crucial to understand that stETH and UST are different. After the Merge, stETH will be redeemable 1:1 for ETH in the bank (Lido). On the other hand, UST can be exchanged for LUNA, however if LUNA is not in demand, UST decreases to 0.
All of this seems fine, however there is a problem when stETH is used as collateral in a market where asset prices are falling. What occurs if illiquid assets are used as collateral?
Why Does the De-peg Matter So Much?
Imagine you have 10 stETH at a cost of $2k each. You are given a $14k loan with a 70% LTV (loan-to-value). When ETH drops 20% to $1.6k, panicked holders of STETH sell their tokens on a CEX. 1 ETH now equals 0.95 ETH.
Your collateral is no longer worth $16,000, but just $15,200! If stETH makes up a sizable portion of your collateral, this has a significant impact. Imagine for a moment that you are a lender with assets and liabilities. Assets: 100% of stETH . Liabilities: 100% of customer ETH deposits
ETH falls by 20%. You only have stETH, but your consumers want their ETH! What’s next? You market your stETH. The stETH:ETH Curve pool is one location where you can accomplish that. “The issue?” A two-sided pool that pairs stETH and ETH is used. There won’t be anyone to sell to once all the ETH has been spent. Technically, your stETH is worthless. It is an unpurchased illiquid asset.
Who Is Caught in the Crossfire?
This is what occurred to the Celsius Network, which leveraged on Lido using user funds as collateral. Customers withdraw money out of concern that Celsius won’t be able to pay.
Celsius has resources but no cash. They consequently sell stETH and turn into a forced seller, which causes stETH to diverge even more. Additionally, Celsius has its stETH secured elsewhere as collateral. Therefore, if the value of stETH drops too much, it can be margin-called. They try to deposit additional collateral and stop customer withdrawals as a result.
These funds and lenders are compelled to sell their assets if they fall insolvent. Prices may fall even farther. That might lead to additional margin calls abroad, prolonging the already terrible collapse of the cryptocurrency market.
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