Ether is the second largest cryptocurrency in the world by market value.
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Another controversial cryptocurrency is wreaking havoc on the digital asset market — and this time, it’s not a stablecoin.
Staked Ether, or stETH, is a token intended to have the same value as Ether. But in recent weeks it has traded at an increasing discount to the second largest cryptocurrency, fanning the flames of a liquidity crisis in the crypto market.
On Friday, stETH fell as low as 0.92 ETH, an 8% discount to Ether.
Here’s everything you need to know about stETH and why it’s worrying crypto investors.
What is STET?
Each stETH token represents an ether unit that has been “staked” or deposited in the so-called “beacon chain”.
Ethereum, the network that underlies Ether, is in the process of upgrading to a new version said to be faster and cheaper to use. The Beacon Chain is a test bed for this upgrade.
Staking is a practice where investors lock their tokens for a period of time to help keep a crypto network secure. In return, they receive remuneration in the form of interest-like income. The mechanism behind this is known as Proof of Stake. It differs from “proof of work” or mining, which requires a lot of processing power – and energy.
Currently, to gamble on Ethereum, users must agree to lock up at least 32 ETH until the network is upgraded to a new standard known as Ethereum 2.0.
However, on a platform called Lido Finance, users can stake any amount of Ether and get a derived token called stETH, which can then be traded or lent on other platforms. It is an important part of decentralized finance that aims to replicate financial services such as credit and insurance using blockchain technology.
StETH is not a stablecoin like Tether or TerraUSD, the “algorithmic” stablecoin that collapsed under the strain of a bankrun last month. It’s more like an IOU – the idea is that stETH holders can redeem their tokens for a corresponding amount of ether once the upgrade is complete.
decoupling from the ether
When the Terra stablecoin project imploded, stETH’s price started trading below Ether’s as investors rushed to exit. A month later, crypto lender Celsius began halting account withdrawals, causing the value of stETH to drop even further.
Celsius acts much like a bank, taking users’ crypto and lending it to other institutions to earn a return on deposits. The company took users’ Ether and staked it through Lido to boost its profits.
Celsius has more than $400 million in stETH deposits, according to data from DeFi analytics site Ape Board. The fear now is that Celsius will have to sell its stETH, which will lead to high losses and put further pressure on the token.
But that is easier said than done. StEth holders will not be able to redeem their tokens for Ether until six to 12 months after an event known as a “merge,” which will complete Ethereum’s transition from Proof of Work to Proof of Stake.
This comes at a price as it means investors will hold on to their stETH unless they choose to sell it on other platforms. One way to do this is to convert stETH to Ether using Curve, a service that pools funds to enable faster token trading.
Curve’s liquidity pool for switching between stETH and Ether “has become quite unbalanced,” said Ryan Shea, an economist at crypto investment firm Trakx.io. Ether makes up less than 20% of the reserves in the pool, meaning there would not be enough liquidity to cover every stETH withdrawal.
“Staked ETH issued by Lido is backed 1:1 with ETH staking deposits,” Lido said in a tweet last week, trying to calm investor fears about stETH’s growing divergence from Ether’s value.
“The exchange rate between stETH:ETH does not reflect the underlying support of your staked ETH, but rather a fluctuating secondary market price.”
crypto contagion
Like many facets of crypto, stETH has been hit by a whirlwind of negative news affecting the sector.
Higher Federal Reserve interest rates have triggered a flight to safer, more liquid assets, which in turn has created liquidity problems for large companies in this space.
Another company with exposure to stETH is Three Arrows Capital, the crypto hedge fund reportedly struggling financially. Public blockchain records show that 3AC has been actively selling its stETH holdings, and 3AC co-founder Zhu Su has previously said his firm is considering selling assets and being bailed out by another firm to avoid a collapse.
3AC could not be reached for comment at the request of CNBC.
Investors fear that stETH’s fall in value will hit even more crypto players.
“There is no central bank in crypto,” Shea said. “Things just have to evolve and it will continue to weigh on crypto asset prices and amplify the negative impact of the macro backdrop.”
Bitcoin briefly dipped below $18,000 per coin on Saturday, pushing deeper into 18-month lows. It has since recovered back above $20,000. Ether fell below $900 at one point before reviving $1,000 on Monday.
The ‘Amalgamation’
The stETH debacle has also raised new concerns about Ethereum’s security. About a third of all ether locked in Ethereum’s Beacon chain is staked via Lido. Some investors worry that this could give a single player too much control over the upgraded Ethereum network.
Ethereum recently completed a dress rehearsal for its much-anticipated merger. The event’s success bodes well for Ethereum’s upgrade, with investors expecting it to happen as early as August. But there’s no telling when it will actually happen – it’s been postponed multiple times.
“The latest updates on Ethereum’s testnets have been positive, giving more confidence to those waiting for the merger,” said Mark Arjoon, research associate at crypto asset management firm CoinShares.
“When withdrawals are eventually enabled, any rebate in stETH will likely be swapped away, but up to this unknown date there will still be some form of rebate.”