What is happening with the stETH depeg and why it represents a massive opportunity for DXdao

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:

  1. 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

  2. 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:

  1. 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.
  2. 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:

19 Likes

This is a sensible take.

If a significant depegging happens from liquidation cascade, the process will be near instant. I think it’s likely well-prepared buyers jump on the chance immediately. As in, mev-bot-immediately, for the peg to flashcrash and for any manual buyer to miss their shot.

Perhaps it would make sense for the DxDao multisig to set limit orders in advance starting at the predefined threshold?

What are onchain options for that purpose? Matcha and 1inch?

5 Likes

I’m not really surprised stETH trades at a discount to ETH.

The way stETH works, if you deposit 1 ETH into it, you’ll have 1 ETH validating on the beacon chain. By end of the year, at 5% APY, through rebasing you’ll have 1.05 ETH in your wallet. However, there is still only 1 ETH validating on the beacon chain (stETH is not auto-compounding) – because the 0.5 ETH don’t exist – at least not until the merge is successfully done. In fact your APY, even if you hold 1.05 ETH, is just on the 1 ETH. So all stETH issued through rebasing doesn’t actually earn APY – it doesn’t even exist. Which is why I’m not surpised it trades at a discount.

By actively purchasing stETH at a discount, we’d be supporting a repeg, which could then incentivize people to deposit new ETH into Lido. So although we’re not minting new stETH, we are indirectly incentivizing it. That’s just a question we have to ask ourselves - do we want to support the most centralized liquid staking option?

Moreover, 5% premium is not so much over a 12-18 month period. The merge was just delayed again yesterday, but most importantly you are not able to withdraw or access the underlying ETH after the merge happens you have to wait for the Capella upgrade. That’ll, likely, take a further 6-12 months, plus there will be queues for exiting validators and limits on amount of validators allowed to exit per day, which I believe is around 900 (i.e. 28800 ETH / day).

I’m not opposed to the idea, but curious to hear what other community members think.

13 Likes

Very interesting thoughts Keenan.

7 Likes

With some differences, there is risk in all liquid staking protocols.
While the situation is still developing, I don’t think we need to rush into this ‘asap’, but I am also in favor of considering it as an option.
The DAO patiently hodls ETH and has presciently diversified into stables near the peak. There is no need to sell any remaining ETH for any other asset any time soon, but stETH is definitely of interest, just not urgent.
A few weeks back the discount was about 2.2%, and now at times it reaches 4.8%. That comes on top of the yield the stake would earn. We should wait a few more weeks, we’re in no hurry. There is also an option for the DAO to LP with wstETH/ETH, but that would require operational overhead.

10 Likes

Perhaps I’m mistaken, but I read Keenan’s idea as positioning DxDao to make the most out of a drastic stETH depeg (rather than a slight discount).

i.e., if it trades at 0.75 ETH per stETH, after a liquidation cascade.

4 Likes

I love this idea, but like Arhat mentions, we dont need to rush into this. Would be good to get a consensus right now around what price point we should start placing our bids (0.7 to 0.8?)

I would also love to do some ETH bought back with the stables if it reaches 700-800 USD range. This could turn out to be high risk as this might affect the 4 year runway, but at 750 to 800 USD, we can start doing daily buys for 5K to 10K, conservatively targetting to buy 1000 more ETH.

9 Likes

Lots of great thoughts here so far, thank you to everyone stepping in with comments or criticism^

To @PhiMarHal’s point, I think the best strategic play is to prepare ourselves to take advantage of a drastic stETH depeg, however, I think there is serious value in very slowly DCA’ing our ETH into stETH based on the DAO’s risk appetite provided the depeg remains below a certain percentage. Say, 5%? This is ETH that we don’t plan on touching until the next bull unless something drastic occurs anyhow, so my opinion is that the instant 7% and staking rewards are a pretty significant financial incentive over holding simply ETH until the next bull.

Love the idea of limit ordering, but unsure which resources tap into curve liq. If stETH scam wicks it’ll likely get bought back up before translating to other resources like 1inch/matcha. It’s still likely the best bet, though.

To @fluidDrop’s points, I also am not surprised after learning exactly how stETH works; even though its not optimal, a majority of purchased stETH would still be earning yield.

Although I understand that we would be in principal incentivizing the deposit of new ETH to Lido, I personally don’t believe that there is going to be much in the way of new deposits until the merge due to market conditions. The ETH community at large is much more knowledgeable about the centralizations risks and has access to many more options at this stage. That’s not to say that this isn’t a problem/consideration, but I feel personally as if it is very minor, and/or we would be helping to support further decentralization by withdrawing our ETH from Lido post unlock.

Last but not least, I disagree with the notion that 5% is not so much over a 1-2 year period. We would be receiving both the instant premium of at least 5% on our ETH (aiming for a deeper discount), as well as any future yield until the unlock. That is of course when pitted in comparison to the ETH sitting idle for at least the same period of time.

Also to note, I agree with @0xVenky’s point of purchasing ETH if we get very low, but this is a topic for a different discussion as it would be a very high risk endeavor in such market conditions. (Plus ETH will go to $400 at least, sorry not sorry :wink: )

6 Likes

Definitely in favour of this.

Is the sETH2 proposal still going ahead though? I agree it’s not super urgent to rush into stETH immediately, but it does seem mad to proceed with the first 500 ETH tranche into sETH2 while there’s 6-7% discount on stETH right?

6 Likes

We agree that increasing the proportion of stETH in the treasury would be a good idea. This would be part of the strategy we would apply for you if we manage DXdao’s treasury. stETH should also be used as collateral to acquire other tokens that would be invested, diversifying the treasury and obtaining a yield that would allow you to leverage the loan.
The stETH collateral would be monitored 24/7 by anti-liquidation bots, to maximize capital efficiency. The increase of the stETH holding would be part of a larger strategy that would keep a healthy diversification of the treasury, avoiding excessive exposure to stETH.

5 Likes

~Two weeks ago Lido began making a proposal to prepare for the bear market
It seems like they have not done it yet, given the price of ETH dropping by more than 50% since the proposal this means they will have much shorter runway.

I’m not sure what is the structure of Lido, and it’s unclear from this proposal.
Are they a full DAO? are these funds meant to pay salaries for everyone who works for Lido? Or do they have a Lido Company, and these funds are strictly to pay for “DAO community” type of work.

We propose to sell 10,000 ETH of Treasury funds to DAI. This should cover about two years for 50-people team & ops expenses of the protocol maintenance budget. With the current staking APY & daily fees numbers that’s the amount Lido DAO would make up in stETH in about a year (~25 ETH / day in rewards for Lido DAO Treasury).

5 Likes

With the current overall depeg of staked ETH, I belive it makes sense to move forward with StakeWise. The depegs are at a similar level (albeit chaning constantly). But to note that any discount on StakeWise is a pure ETH discount, as rewards are accrued through a separate token.

7 Likes

I like the idea of getting staked ETH at a discount, but I suggest DXdao developers thoroughly review the code of any staking contract before going through with this, to be certain the funds cannot be stolen. I’m reminded of crETH, (creamFinanceETH), which was trading at a decent discount to ETH for some time… But, it was likely trading at a discount because someone knew it could be hacked, and it later was drained of all its value:

3 Likes