If you have been hanging about the cryptoverse (cryptoland? CT?) for the past few months, chances are you are intimately familiar with the collapse of Luna/UST and the subsequent depeg fears that followed in its wake. Fears of a bank run and subsequent collapse of the largest stable asset, USDT, was on everyone’s mind (including myself). When you really start to look into the ripple effects of such a collapse, it’s enough to strike fear into anyone. Bridges, DeFi protocols, DAO treasuries, CEX’s, all at a significant risk in such a scenario.
While this was happening Tether CEO @paoloardoino took to Twitter to reiterate that all Tether was backed 1:1 by USD and that all redemptions would be honored through Tether.io regardless of current market rate. As the dust settled, Tether had executed over $10b in redemptions, released a breakdown of its reserves for the first time, and had lost its peg by roughly 4% for only a single day. The YTD market cap of Tether paints an interesting story.
As these major events were unfolding, everyone kept their eyes peeled for other depeg risks. The most interesting one? stETH. Lido’s stETH represents staked ETH on the Ethereum beacon chain, which is not accessible until the merge has been executed successfully. It is backed completely 1 to 1 against ETH, unlike the UST/LUNA debacle, and all accrued ETH rewards are redistributed as additional stETH to holders. DXdao actually owns 512 stETH at present time, authorized in this proposal. So where does the problem lie? Well, stETH started to depeg roughly a month ago, and is now starting to accelerate in losing its peg. Everyone panic! DXdao needs to remove its exposure to stETH now! Well… actually no. Below I will go through the current status and reasoning of the stETH depeg, and why instead of a risk it actually presents a massive opportunity to DXdao.
stETH depeg? How does that work?
Since stETH is a liquid claim on the underlying staked ETH, and the ETH is not redeemable until the merge has been successfully executed on mainnet, it operates in the open market similarly to any other asset. If you want liquidity you’d need to sell your stETH. The primary place to do this is the stETH/ETH pool on mainnet Curve. As of the time of writing, the current pool balance is roughly 80% stETH and 20% ETH, resulting in slippage for those looking to exit their positions or access liquidity. But wait, the merge is only months out. Why are people still exiting their stETH positions at a loss?
Thanks to a handful of useful posts/documentation (found at the footer), I started to better understand the fear surrounding stETH; and no, it’s not protocol risk or a silent extraction of funds. stETH WILL be redeemable 1 for 1 for ETH at redemption post merge, BUT, it is incredibly likely that the peg continues to slip, or more importantly, a cascade of liquidations could bring the market price of stETH to insanely low levels. Let me explain the possibilities.
Celsius network, known for their crypto staking/borrowing platform, have a large 409k position in stETH equating to nearly $700m deposited as collateral gaining over $1.2B in debt. Due to a variety of hacks and losses that aren’t yet fully quantified, Celsius is “functionally insolvent” on their ETH position, requiring them to realize significant losses to an illiquid and rapidly depegging stETH in the event that they run out of ETH capital to honor redemptions. With a current pace of 50k ETH withdrawn a week, Celsius has a little over 4 weeks on the clock before this becomes reality. For reference on the losses, that we know of, they lost $70m in Stakehound, $50m in the Badger front-end exploit, and over $500m wound within various Luna or UST positions.
@SmallCapScience gives two options for Celcius if their ETH liquidity runs dry:
Investors attempting to redeem their positions at a rate of around 50k $ETH per week means
@CelsiusNetwork
has two options.1 . Sell their $stETH for $ETH and then stablecoin in order to become more liquid.
2. Use the $stETH as collateral and take out loans to repay customers
Regarding the first option, if forced to sell or liquidate their 450k stETH position, they would be doing so against a pool that presently only has ~132k ETH, representing a hypothetical loss of roughly 70% growing by the day. (Of course, not nearly this simple to quantify).
Similarly when focusing on his option two, its worth noting that Celcius already has significant stETH debt, nearly half of the stETH currently utilized as collateral. A forced liquidation could reasonably result in a similar death spiral to Luna/UST, where instead of a redemption function causing the pain, it is their underlying position is losing value due to the sale of stETH alongside increased borrowing rates
This is all surrounding a SINGLE stETH holder, where there are many other entities and individuals with significant stETH balances. There is also a very high probability of other large entities forcing Celcius’ hand and accelerating any liquidation cascades.
Whew, this all sounds pretty bad. Time for DXdao to dump stETH? Still… no. Remember earlier when I mentioned that stETH is redeemable 1 to 1 for ETH post merge? Well, that is all but guaranteed through the code as supported by various audits. Of course, there are a few more moving parts when taking into account the amount of processes that do not normally communicate. Here is some context from @vshvsh in the ethresearch forum:
Here are events and processes that need to be accounted for for a purpose of a withdrawal process in Lido.
Withdrawal request from a staker
Withdrawal signal from a validator
Oracle reports on network state
Ongoing rewards and penalties
Ongoing slashings
Unbonding period
New penalties and slashings during onbonding
Network turbulence (e.g. lack of finality)
The proposal
Considering that a 1 to 1 conversion is nearly guaranteed, a scaling position outside the scope of DXdao’s regular ETH staking initiatives appears to me to be a massive opportunity. The risks involved that should be considered include:
-
DXdao requiring the immediate use of any ETH traded to stETH, which would require the DAO to unwind portions of a hypothetical stETH position at a loss before it is redeemable post merge
-
Lido smart contract risk and potential for loss of funds/exploits post redemption period
Of course, position liquidation would be a risk as well, but DXdao should in my opinion never utilize leverage for the purposes of its safe ETH balances, and the simple conversion of ETH to stETH involves zero liquidation risk.
Now onto the benefits to DXdao:
- Even at current market rates, DXdao can gain a significant amount of ETH in a short period of time. In the event of a delay in the merge, DXdao would not have been selling its ETH regardless and will be accuring additional rewards on the balance.
- DXdao will also accelerate its staked ETH positions, which will be even more important in a post merge world.
At current balances, a hypothetical conversion of DXdao’s liquid ETH in the mainnet treasury would result in an “instant” gain of around 470 ETH, which is roughly $800k at current prices (which also doesn’t matter to us, right folks?) or 5.2% increase on our ETH balance.
Of course, I am not insinuating that we should risk all our ETH in this situation, but here is what I would propose (and will be bringing to a signal proposal ASAP).
DXdao should immediately pledge 1000 ETH (perhaps even 2000 depending on other ETH staking initiatives) to the DXdao multi-chain multi-sig for speedy execution of a ETH to stETH conversion provided the above conditions become met and the peg reaches a set execution threshold, say, 25%. In the event that this never occurs the multi-sig would be responsible for returning the funds on or before the merge.
In addition to this, I propose that a weekly funding proposal for 250 ETH, scaling up in the event of further depegging, be submitted on mainnet and used to convert into additional stETH through curve.
Conclusion
DXdao entering a sizable stETH position, to me, is a low risk high reward endeavor based on our positioning and sizable runway allowing us to hold ETH for a long period of time. Due to DXdao’s decentralization first approach, we also have the ability to migrate the ETH from Lido to other staking solutions post merge to further decentralize the Ethereum network. (Trading into stETH does not mint more). I would love any community feedback before taking the above actions to a formal proposal early next week. Thanks and have a great weekend!
Above mentioned useful resources/references for this post:
- Lido contracts
- Curve stETH pool (vast majority of on-chain liquidity)
- Fantastic thread from @SmallCapScience surrounding entire stETH debacle
- Another fantastic overview thread by @riley_gmi
- @Yieldchad thread on Celcius ETH insolvency
- Celcius wallet containing stETH positions
- stETH holders on Etherscan
- @HsakaTrades thread on Alameda unwinding ~$100m in stETH positions
- @CoryKlippsten thread on stETH depeg, associated investors and similarities to UST death spiral
- Aave stETH market
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