Risk and Reward
Even under normal market conditions, keeping stETH’s value pegged to Ether is tricky as the staked token comes with counterparty risks and won’t be redeemable until sometime after the Merge, said BlockTower’s Rai. The Merge has been postponed several times and is now anticipated to take place later this summer or toward the end of the year.
Possible “liquidation cascades” are also a concern, said Tarun Chitra, co-founder of crypto risk modeling platform Gauntlet.
“If you’re doing the [arbitrage] but can’t hold through a large liquidation event, then you might sell into that event and cause the price to go down further,” Chitra said. “So you need to be very cognizant of the amount of leverage used.”
One of the most popular stETH trades involves using the token as collateral on Aave in order to borrow more Ether and then stake that borrowed Ether with Lido, resulting in even more stETH. But as stETH’s discount to Ether deepens, loans on Aave using stETH as collateral could be liquidated, driving the price of stETH further from Ether and causing even more loan liquidation, Chitra explained.
More than 1 million stETH sits on Aave at the moment, according to Nansen.
“Fire Sale”
The team behind Lido has been aware of the discount for months, Vasiliy Shapovalov -- one of the platform’s main developers -- told Bloomberg. Since May 13, its staking page has pushed out notifications encouraging users to buy discounted stETH on decentralized exchange 1inch “rather than staking directly with Lido.”
The token was meant to be a solution to Ether staking, which is a way for investors to lock up their Ether and earn rewards ahead of the network’s Merge upgrade. While directly staking Ether locks up the coins for months at a time, Lido’s solution offers users stETH that they can trade, lend and borrow with instead.
Even so, this isn’t the first time that stETH has traded at a deep discount to Ether, said Shapovalov. In April 2021, a steep drop in Ether’s price caused the gap to widen between the two tokens.
“In the situation of a fire sale over all of the market and when Ether has better liquidity than stETH, both are necessary, stETH will trade at discount,” said Shapovalov.
--With assistance from Samuel Dodge.
This article was provided by Bloomberg News.