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 that is supposed to have the same value as ether. But over the past few weeks, it has been trading at a growing discount to the second-largest cryptocurrency, fanning the flames of a liquidity crunch in the crypto market.
On Friday, stETH fell to 0.92 ETH, implying an 8% discount on Ether.
Here’s everything you need to know about stETH and why it has crypto investors worried.
What is stETH?
Each stETH token represents a unit of ether that has been ‘staked’ or deposited into what is called the ‘beacon chain’.
Ethereum, the network behind Ether, is moving to a new version that is supposed to be faster and cheaper to use. The Beacon Chain is a test environment for this upgrade.
Staking is a practice where investors lock up their tokens for a period of time to help keep a cryptonet secure. In return, they receive rewards in the form of interest-like returns. The mechanism behind this is known as “proof of stake”. This is different from “proof of work” or mining, which requires a lot of computing power and energy.
To bet on Ethereum currently, users must agree to lock up a minimum of 32 ETH until the network is upgraded to a new standard, known as Ethereum 2.0.
However, a platform called Lido Finance allows users to stake any amount of ether and receive a derivative token called stETH, which can then be traded or loaned on other platforms. It is an important part of decentralized finance, which aims to replicate financial services like loans and insurance using blockchain technology.
StETH is not a stablecoin like tether or terraUSD, the “algorithmic” stablecoin that collapsed last month under the pressure of a bank run. It’s more like an IOU – the idea being that stETH holders can exchange their tokens for an equivalent amount of ether once the upgrade is complete.
When the Terra stablecoin project imploded, the price of stETH began trading below that of ether as investors rushed for the exit. A month later, crypto lender Celsius started the halt in account withdrawals, which saw the value of stETH drop even further.
Celsius acts much like a bank, taking crypto from users and lending it to other institutions to generate a return on deposits. The company took ether from users and staked it through Lido to increase its profits.
Celsius has over $400 million in stETH deposits, according to data from DeFi analyst site Ape Board. The fear now is that Celsius will have to sell its stETH, which would lead to heavy losses and put more downward pressure on the token.
But that’s easier said than done. StETh holders will not be able to exchange their tokens for Ether until six to 12 months after an event known as the “merger”, which will complete Ethereum’s transition from proof-of-work to proof-of-stake.
This comes at a price, as it means investors are stuck with 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 exchange.
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 represents less than 20% of pool reserves, which means there would not be enough liquidity to meet every withdrawal of stETH.
“Staked ETH issued by Lido is backed 1:1 with ETH staking deposits,” Lido said in a tweet last week, attempting to allay investor fears over stETH’s growing divergence from the value of ether.
“The exchange rate between stETH:ETH does not reflect the underlying support of your staked ETH, but rather a fluctuating price in the secondary market.”
Like many facets of crypto, stETH has been caught in a whirlwind of negative news impacting the industry.
The Federal Reserve’s interest rate hike triggered a flight to safer and more liquid assets, which in turn led to liquidity problems at the big companies in the space.
Another company exposed to stETH is Three Arrows Capital, the crypto hedge fund that is reportedly struggling financially. Public blockchain records show that 3AC has been actively sell stETH holdingsand 3AC co-founder Zhu Su previously said his company was considering selling assets and bailing out another company to avoid collapse.
3AC was unavailable for comment when contacted by CNBC.
Investors fear that the drop in value of stETH will hit even more crypto players.
“In crypto, there is no central bank,” Shea said. “Things will just have to play out, and that will continue to weigh on crypto asset prices, compounding the negative impact of the macro backdrop.”
Bitcoin briefly dipped below $18,000 a coin on Saturday, plunging deeper into 18-month lows. It has since recovered above $20,000. Ether at one point fell below $900, before rallying back to $1,000 on Monday.
The stETH debacle has also raised new concerns about the security of Ethereum. About a third of all ether locked up in Ethereum’s beacon chain is staked by Lido. Some investors are concerned that this will give a single player too much control over the upgraded Ethereum network.
Ethereum recently completed a dress rehearsal for its long-awaited merger. The success of the event bodes well for the Ethereum upgrade, with investors expecting it to take place as soon as August. But it’s unclear when that will actually happen – it’s already been delayed several times.
“The latest updates on Ethereum’s testnets have been positive, providing more confidence for those awaiting the merger,” said Mark Arjoon, research associate at crypto asset management firm CoinShares. .
“So when withdrawals are finally enabled, any rebate in stETH will likely be arbitrated, but until that unknown date there will still be some form of rebate.”