Weekend of Double Trouble
CPI print on Friday was highest since 1981, but also above expectations resulting in a risk off price action across global markets. While crypto markets were absorbing the red hot CPI numbers holding up this during the weekend(which are relatively less liquid times) when markets started to see forced selling, this time deleveraging was lead by staked stETH-ETH.
What is stETH?
One of the biggest concerns regarding staking in ETH 2.0 has been around the uncertainty of when the merge would actually happen, as people are not comfortable locking their inventory for an indefinite period. A defi application Lido Finance introduced a liquid staking derivative stETH. You stake 1 ETH with Lido and the issue you 1 stETH, your 1 ETH is staked with a validator from a set of node operators chosen by Lido. As staked ETH earns staking rewards your stETH balance gets automatically matched with the ETH balance on beacon chain. But in the meantime you can move your stETH among a list of supported defi platforms where you can borrow/trade stETH into ETH, borrowed ETH can be further staked into Lido enhancing staking rewards. Ability to leverage and uncertainty on ETH merge timelines Lido Finance were the main drivers of the rapid growth of total value locked(TVL) in Lido Finance that topped to 20bln+ in April 2022 before retracing on the sell off led by UST collapse. This weekend’s price action seems to be liquidity driven, if you hold stETH- you can either get back ETH by redeeming after the merge event is successful & ready for redemptions or you can sell stETH to ETH on the markets. Apart from the early days of stETH launch, stETH-ETH has been trading at parity until may 2022 when the entire defi space saw people taking out their assets out of these platforms.
Arbs & Efficient markets theory in a broken market structure
An arbitrage opportunity will be created each time setETH-ETH trades above or below 1, and arbitrageurs will trade until the price comes back to parity. If 1 stETH traded for 1.2 ETH in the markets then traders can mint 1 stETH with 1 ETH on lido and then sell it to the markets for 1.2 ETH. If 1 stETH traded for 0.8 ETH in the markets the trader can buy 1 stETH for 0.8 ETH from the markets and redeem it for 1 ETH on Lido finance, But the problem is that redemption only gets enabled once merge is done successfully, which no one has a certain answer to. While in a bull market stETH trading at a discount would be seen as an opportunity by market participants to acquire eth staking rewards at a discounted price, in a bear market it would be quite opposite as no one wants to hold their staked (long time commitment) positions which in a low liquidity environment will cause the divergence to widen.
Forced sellers and one way market
Majority of the forced selling came from liquidations of leveraged stakers or stakers who had a huge short dated liability of settling ETH on other side(probably due to massive withdrawals). These forced sellers were exchanging their stETH for ETH at a discounted price both on lit and OTC markets. The liquidity providers taking the other side of this trade were dumping ETH both on spot and derivative (perpetual swaps & futures) to off load their ETH market exposure risk arising by owning these hefty amounts of stETH. While crypto markets operate 24x7, off late we have seen the liquidity has been thinner over the weekends coupled with bad market sentiment (across the board) led to significant price impact dragging the entire market down.
What is next?
Lido Finance was innovative in creating this liquid staking derivative but it did not meet our risk parameters even after considering the higher ETH staking rewards through levering that were (previously) considered to be a low risk strategy among many market participants. We work to provide our clients with innovative products with high standards in an effort to build crypto for everyone.