stETH<>ETH peg (not a peg) presents a dilemma and opportunity for ETH bulls
How low will it go? Also, not a peg.
stETH starting to drop in price relative to ETH is the latest event in an ever-growing line of bear market dramas we are forced to endure.
For most of its history, stETH has traded on par with ETH — with the downwards price action beginning from the Luna/UST fiasco and increasing in the past 24 hours. The discount for stETH is 3.9% at the time of writing this post.
How the discount fluctuates going forward — and what that means for Ethereum holders — will likely garner increasing attention in the coming days.
To illuminate the dynamics at play, this post is structured in 3 parts:
What the stETH-to-ETH relationship is (and why it’s not a peg).
The latest on-chain events.
Who the market participants are and forecasting their actions.
stETH-to-ETH, what is the right price?
The common misunderstanding about stETH is that the price is a peg and the game theory for market participants resembles UST.
This is wrong.
There’s no “need” for stETH to maintain a tight correlation to the ETH price. It doesn’t matter if it goes it fluctuates 90% below the ETH price or 50% above it. Confidence can’t be lost because of price action.
stETH is fully backed by ETH on the beacon chain. The factors that influence the price in the big picture are:
Liquidity discount because the stETH can’t be redeemed until after the merge.
Appetite for earning staking yields (currently at 4.0%).
Some risk premium because Lido has smart contracts and governance layered on Ethereum staking.
TLDR; buy stETH now and get ETH back post-merge. How you value and price that particular exercise is totally up to you.
In practice, prices are determined by the marginal seller or buyer, and there’s only $1.2 billion worth of stETH and ETH in the main liquidity venue on Curve. Selling stETH for ETH in about the $200 million range without buyers on the other side would essentially break the Curve AMM function and lead to a significantly lower stETH price.
Who is selling to drop the stETH price (and why)?
A notable entity yesterday sold close to $100 million in stETH to ETH. Since it’s impossible to know for sure and I don’t want to wildly speculate — let’s just call this entity “Alamo Research” for the purposes of this article.
When it comes to bank runs, there are a few usual suspects who you would expect to be ahead of the curve. The initial drop started during the UST de-pegging event when another player — let’s call them “Jumping Capital” market dumped $51 million in stETH to ETH, and the UST, to defend the $1 price.
The seller could also be a larger holder like Celsius, who has to sell their stETH to cover ETH withdrawals for their customers. It’s hard to tell how dire their situation exactly is, but among people I’ve talked to, there is a legitimate worry they will run out of funds — either they are selling now or being front-run.
Looking at the data, there are quite a few dip buyers in the 100-1,000 stETH range, but almost everyone above 1,000 stETH is a seller so far.
Who gets screwed and who buys the dip?
There are 2 groups of stETH holders who would seem to be in danger:
As outlined by @SmallCapScience, an entity like Celsius has to sell stETH to ETH to cover customer withdrawals (at an increasingly worse price).
Leveraged yield farmers (e.g. the Instadapp Lite vault). The cascading liquidations would begin closer to 0.85.
It’s hard to know in how much trouble e.g. the Instadapp vault is. Users can force deleverage themselves for a 15% penalty (a feature that has been called quite a few times in the past hours). Previously, the Instadapp team was able to borrow USDC to cover the vault and could do so again to drop the liquidation level much lower.
For long-term ETH holders, the current situation presents an interesting dilemma and opportunity.
The current market sentiment is bad and it seems there’s a non-trivial chance of cascading liquidations. That then pushes the stETH price really low (theoretically, to the 0.65 range). It makes sense to wait for that opportunity because the arbitrage is so simple — with the merge and visibility into withdrawals increasing, the stETH price will be fine as long as nothing disastrous happens.
The question is when to enter a stETH position.
To buy now is to “gain” a few percentage points at best while waiting could open up a much better opportunity (riding the train from e.g. 0.70 to 0.98). A large drop might be front-run because if one is bullish about ETH, buying stETH at a discount is the easiest no-brainer decision you can imagine.
If you are not planning on selling your ETH, the merge not happening and redemptions never materializing is the borderline equivalent of something so bad happening that the ETH isn’t worth much anyway.
The only question remains: when do buyers step in?
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