stETH – synthetic token that brought funds and lending protocols to the collapse4 min read
June was the month in which the cryptocurrency market faced a true meltdown.
And it wasn’t just price that the market faced problems, as several investment funds and lending protocols recorded heavy losses. The cases of the Three Arrows Capital (3AC) fund and the Celsius Network had the greatest impact.
3AC has experienced massive liquidity losses and recently defaulted on a $660 million loan to exchange Voyager Digital, while Celsius has stalled customer withdrawals and has no date for resuming operations.
Aside from the collapse, 3AC and Celsius have one other thing in common: their troubles started over a synthetic ETH token called stETH. So, learn more about this token and how it led the market to the current bearish scenario, based on information from Delphi Digital.
What is STETH?
stETH is a synthetic token, that is, its value is linked to another independent asset. In this case, the value of ETH. This token is used especially in staking platforms, among which Lido Finance stands out.
As ETH has not yet made its switch from mining to Proof of Stake (PoS), activity is restricted to a few protocols. stETH acts as a synthetic in these protocols: each time someone deposits ETH into staking, they receive an amount of stETH.
Likewise, when withdrawals are activated, holders will be able to redeem stETH at a one-to-one rate. Since the system works like this, stETH should, in the best case scenario, be worth the same (in dollars) as an ETH is worth.
However, there are times when stETH can fluctuate in value. Every time this happens, investors have an opportunity to profit through arbitrage:
- If stETH is trading above an ETH, users can deposit ETH on Lido and receive stETH in return, selling the stETH on the open market;
- If stETH is trading below one ETH, users can buy stETH at a discount and redeem it for ETH, selling the ETH.
In both cases, the investor profits from the price difference in the transaction.
However, Lido has not yet enabled ETH withdrawals on the platform. Therefore, stETH maintains its link to ETH through a pool on the decentralized exchange (DEX) Curve called StableSwap.
Recently, this pool became unbalanced, i.e. it had more stETH than ETH. As a result, the token was traded at a discount of up to 5% against ETH. And it was this discount that started the problem.
Relationship between stETH and ETH
Before understanding the discount, it is important to highlight the magnitude of Lido and stETH in relation to ETH staking.
According to data from Lido and Delphi Digital, the protocol alone holds 32% of all ETH left in staking. In absolute numbers, this means 3.3% of the total ETH supply in circulation, that is, more than four million ETH are allocated on Lido.
In addition, stETH is the largest synthetic token in this market, holding 90% of the total share. These liquidity and network effects are extremely strong on ETH and have allowed stETH to be integrated into Aave and Maker as a form of collateral.
These integrations serve as a major advantage for stETH, allowing investors to utilize the token in decentralized finance (DeFi) as if it were ETH. At the same time, the operation allowed investors to obtain returns – currently 4.07%.
Given stETH’s dominant market position within ETH staking, what caused the token’s parity loss?
As mentioned earlier, stETH is not yet redeemable for ETH. Therefore, it has maintained its peg through the StableSwap pool, which operates the stETH-ETH pair. The problem is that with the devaluation of ETH in the market, the pool started to lose liquidity.
To worsen, the ratio is 80/20 in favor of stETH, that is, it has much more stETH than ETH. That’s why the token lost a lot of its value, reaching a discount of up to 8% in relation to ETH.
And this is where Celsius and 3AC come in. The two major players in the market had significant exposure to stETH through the pools.
Due to their problems, they were forced to undo a large part of their position (hundreds of thousands of stETH), selling a lot of stETH on the market. As there were more sellers than buyers of the token, its parity came under significant pressure.
This untying, coupled with a larger sell-off from the market, caused those using stETH as collateral for DeFi loans to start repaying their loans.
In short, investors liquidated their loans in search of immediate liquidity – something stETH cannot yet provide. As a result, the price dropped even further.
It is not known how far this crisis will go or if stETH will still recover its parity. But until the market recovers, the token is likely to continue trading at a strong discount.
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