Recently, rumors about the insolvency of the well-known lending platform Celsius have been rampant, and Celsius and other large institutions in crisis have sold assets to raise funds, triggering the decoupling of stETH prices. Currently, the exchange rate between stETH and ETH on Curve is maintained at around 0.937. The decoupling of stETH from the price of ETH has caused panic in the market. Some people worry that stETH will follow in the footsteps of UST, and the price will fall into a death spiral.
So, what exactly is Celsius’s large holding of stETH? Is the price of stETH at risk of a death spiral?
In order to clarify these, let's first understand the generation mechanism of stETH.
What is stETH? What is Lido? stETH is a pledge certificate generated by users who pledge ETH through the Lido protocol and participate in the POS of the Ethereum network. Lido is a decentralized non-custodial staking protocol.
Ethereum will complete the upgrade and merger from POW to POS this year. Before that, a part of pledged ETH is needed to ensure the security of the network, and chain pledges can obtain certain pledge rewards. After the network is merged, this part of ETH can be withdrawn.
For ordinary users, if they want to directly participate in POS, they will face many restrictions, such as the pledge quantity threshold (Ethereum chain requires a minimum pledge of 32 ETH), the technical threshold and hardware cost of becoming a verification node, and the opportunity cost and Lack of liquidity (users cannot withdraw pledged ETH until the Ethereum mainnet is merged).
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How Lido works
The roles involved in Lido mainly include users (Depositor, pledger) and node operators (Validator node operator, verifier). Users entrust pledged assets to node operators through Lido's smart contracts.
Node operators are responsible for the actual pledge work on the chain in the pledge agreement, while users deposit and withdraw pledged assets and mint or burn ST assets through the pledge pool contract.
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The reason for the stETH discount
After understanding the generation mechanism of stETH, let's take a look at why stETH has a discount.
The main reasons for the price discount of stETH are:
Compared with ETH, the liquidity of stETH is far from sufficient. In order to make up for this part of the liquidity cost, a discount is generated;
At present, a large number of institutions holding stETH urgently need to sell the stETH in their hands to obtain funds to deal with user withdrawals or replenish margins to prevent collateral from being liquidated. In the face of huge selling pressure, stETH will inevitably produce further discounts;
Whether Ethereum can be merged successfully and on time determines the time when stETH finally obtains ETH liquidity;
Risks of the Lido protocol and smart contracts.
Let's look at them one by one.
The first is the liquidity of stETH.
There are about 12.8 million ETH pledged on Ethereum, of which about 4.1 million are pledged through Lido, accounting for 32% of the total.
From the above introduction, we can know that before the realization of Ethereum 2.0, this part of ETH pledged by users cannot be redeemed, and users can only obtain liquidity by staking their stETH on certain DeFi platforms, or in the secondary market Sell stETH.
According to Messari’s data, as of the end of May, the stETH in circulation was mainly concentrated in the two protocols of Aave and Curve, and the stETH in these two protocols accounted for two-thirds of the total circulation.
For stETH holders looking to sell, the decentralized exchange Curve offers a stETH-ETH liquidity pool where stakers can convert stETH to ETH. Curve's liquidity pool is currently the deepest market for stETH among Dex platforms.
However, after entering June, as the price of ETH plummeted, a large amount of liquidity was withdrawn from Curve's liquidity pool. From May 18 to June 21, the liquidity of the pool increased from 1.7 billion The U.S. dollar fell to 670 million U.S. dollars.
At the same time, more and more stETH is being converted into ETH, resulting in a serious imbalance in the ratio of the two assets in the pool, even reaching the ratio of stETH:ETH=80%:20%.
As of today, there are only about 120,000 ETH in the pool, that is to say, it can only accept a maximum of 120,000 stETH selling orders (equivalent to US$133 million). A month ago, the number was 290,000. But know that Celsius alone holds more than 450,000 stETH in Aave. With Curve's pool alone, it may be difficult to absorb the demand for selling stETH in the market.
May 18, 2022:
June 21, 2022:
As for centralized exchanges, the trading depth is even more negligible. FTX is currently the only centralized exchange that can trade stETH. According to the data on the Kaiko website, in 2022, about 98.5% of the transaction volume of stETH will take place on Curve, and the liquidity on other platforms will be almost negligible.
In the event that an open market sale is not an option, obtaining funds through mortgages becomes another option. According to the data on the chain, both Celsius and Amber have recently sent a large amount of stETH to the FTX address.
At the same time, the number of open positions of FTX has increased significantly, while at the same time, the number of open contracts of exchanges such as Binance and Okex has decreased due to the sharp drop in the market.
So a reasonable guess is that Celsius and Amber mortgaged or sold a large amount of stETH to FTX through over-the-counter transactions. At the same time, FTX hedged the price of this part of stETH by opening contracts to reduce the risk of holding.
After reading the liquidity situation in the market, let's look at the short-term supply and demand.
In the bull market, many institutions holding stETH choose to carry out circular pledges to increase leverage to expand asset scale and improve capital efficiency. They pledge stETH on Aave and other platforms to exchange for ETH, and then pledge the borrowed ETH on Lido to obtain stETH. When the market is rising, there will be no problem with this approach, and institutions will always hold it, and the exchange rate between stETH and ETH can remain stable.
But when a bear market hits, that model becomes problematic. The continuous decline in the value of mortgage assets will trigger the requirement of supplementary margin, forcing institutions to sell their assets in exchange for funds.
A large amount of selling demand in a short period of time will produce an effect similar to a run. The price falls and sells more, and the more you sell, the more it falls, forming negative feedback, accelerating the generation of discounts, and deviating from the original anchor level.
Judging from the data on the chain, among the institutional investors of stETH, at least Three Arrows, Alameda Research (founded by SBF), Amber and Celsius have recently sold off. The amount of stETH held by smart money addresses on the chain also dropped from 160,000 to 27,800 within a month.
A large number of selling orders have accumulated in a short period of time, and the buying orders have not kept up. The lack of depth has caused the market to be smashed through, so further discounts have occurred.
Another risk is delayed Ethereum mergers.
stETH is a derivative of ETH. To some extent, it is similar to ETH futures, because the pledged ETH can only be withdrawn at a certain point in the future, and this point in time is after the merger of the Ethereum network is completed.
If the time of network merging is delayed, it means that the time to withdraw ETH is delayed, which will further deteriorate the liquidity and lower the price of stETH.
The final risk comes from Lido's smart contracts themselves.
The Lido protocol involves several major contracts such as the node operator registration contract, the pledge pool contract, and the Lido Oracle, which respectively control processes such as node access, pledge asset access, and pledge pool balance calculations. To the security of the assets pledged by users. In order to make up for this part of the risk, stETH will also generate a part of the discount.
Based on the above, poor liquidity, insufficient buying, large and urgent selling demand, coupled with the uncertainty of Ethereum network upgrades and the risks of Lido protocol smart contracts, it is not surprising that stETH has a discount.
So the final question is, will the price of stETH enter a death spiral?
The author thinks not. From the mechanism of stETH, it can be seen that its source of value is different from the mutual empowerment design of UST and LUNA dual currencies. The decline of Luna will drive the decline of UST, forming a negative feedback. As a stable currency, UST does not have enough collateral to support its value.
But stETH has strong value support. After the merger of Ethereum, 1 stETH can be exchanged for 1 ETH. This essentially guarantees the value of stETH, differentiating it from undercollateralized stablecoins.
Although in the short term, due to the lack of liquidity, the prices of stETH and ETH have de-anchored, but for long-term investors in the ETH currency standard who do not need funds urgently, it is very cost-effective to buy discounted stETH and hold it until the ETH is unlocked.
Therefore, when the discount reaches a certain level, it will inevitably attract arbitrageurs to enter the market, and then the buying and selling orders will be rebalanced. When the deleveraging process is completed, speculators are eliminated, and stETH returns to long-term investors, it is believed that its price can also return to the right track.
