UST’s collapse continues to reverberate around crypto markets.
Curve’s largest pool is out of whack — the stETH pool, which pairs ETH with stETH, a staking derivative of ETH, shows stETH trading at a 4.7% discount to ETH. Normally the two assets trade on nearly a one-to-one basis.
Dash for Cash
The imbalance may indicate investors are dumping illiquid assets, such as a derivative of ETH locked in Ethereum’s proof-of-stake chain, and rushing to cash.
stETH is a token issued by Lido Finance. Users stake their ETH via Lido in exchange for stETH, on a one-to-one basis. Later when Lido unlocks the ETH after withdrawals from Ethereum’s Beacon Chain are live, users should be able to redeem their stETH for their ETH, plus the accrued staking rewards.
In the meantime, users have stETH, an asset to potentially earn yield with, all while also earning staking rewards through Lido. Like many moves in crypto, this one comes with the risk that stETH keeps its peg — something it has done so far thanks to the stETH pool on Curve which is heavily incentivized by Lido.
After deploying another stETH pool on May 12 Lido, has now tweeted about discount on stETH on Curve. In the thread the project emphasized that while longterm stETH holders aren’t at risk, those who have borrowed against their staking derivative are.
ETH currently consists of 21.6.7% of the liquidity pool with stETH making up the other 78.4%. The pool has $1.8B in TVL as of May 13. The imbalance in the pool creates the discount as traders appear to be swapping their stETH for ETH. As a general rule when it comes to liquidity pools, the scarcer asset tends to trade at a premium.
It isn’t immediately clear why people are dumping their stETH. “Not sure of the rationale driving this move,” DeFi influencer Degen Spartan tweeted about the pool’s imbalance.
But the departure from ETH-stETH parity certainly has people talking — users take loans out against stETH in order to increase leverage while also benefiting from ETH staking rewards which will be unlocked after Ethereum’s Merge.
So if stETH’s value collapses relative to ETH, users could get liquidated as the value of their loan increases relative to the collateralized staking derivative — this may already be happening. For example, a user who borrowed ETH against their stETH got liquidated on Aave.
According to a chart by data provider Parsec Finance, if the price of stETH falls a bit below 0.95 ETH, it will cause over $200M of liquidations on Aave. This number will increase the further stETH falls, in a classic liquidation cascade scenario.
0xngmi, the founder of DeFi Llama, corroborated the number on Twitter.
Additional LDO Incentives
For now, it appears Lido’s new Curve pool hasn’t been enough to maintain parity between ETH and its staked derivative. “We are deploying an additional Curve Finance pool to improve liquidity around the stETH:ETH peg,” the project tweeted on May 12 as concerns about diverging prices circulated. Lido is offering 1M LDO tokens, worth $1.34M at current prices, as incentives for users to provide liquidity to the new pool.
While DeFi influencer 0xHamZ cited a mammoth $33.6M trade of ETH for stETH on Etherscan as evidence that concerns about stETH losing its peg to ETH have passed, the deviation between the two asset prices has only increased.
Now, Spencer Noon, co-founder of Variant, the crypto fund, is warning of potential liquidations.
If anyone in DeFi feels like they’ve already had too turbulence this week, they may need to brace themselves for another depegging which threatens to start a cascade of liquidations.