Betting on the Merge — The Staked Ethereum Arbitrage Opportunity
The fabled Ethereum merge is something that has been discussed and speculated on for months now. Many are bullish on the potential for Ethereum when the chain transitions from proof of work to proof of stake. There are some Defi Degens who are even making calculated bets on a potential arbitrage play that can have serious payoffs when Ethereum 2.0 is deployed and “The Merge” finally happens.
Here is what you need to know:
Currently, you can deposit Ethereum — ETH on Lido Finance in exchange for staked Ethereum — stETH. Lido’s staking service rewards users with a percentage of yield for effectively locking up their ETH on the exchange platform. Staked Ethereum is a derivative token of Ethereum that represents a 1:1 equivalent of ETH that has been staked for an extended period of time to support and secure the Ethereum blockchain network running on the Beacon Chain. The Beacon Chain is a parallel ghost version of the Ethereum blockchain that uses proof of stake instead of proof of work.
“The Beacon Chain, at first, will exist separately to the Ethereum Mainnet we use today. But eventually, they will be connected. The plan is to “merge” Mainnet into the proof-of-stake system that’s controlled and coordinated by the Beacon Chain.” — Ethereum.org
stETH effectively functions as an IOU and could be exchanged for an equivalent amount of ETH when the Ethereum blockchain finally transitions over from proof of work to proof of stake during what is being referred to as “The Merge”. Many users are inclined to earn yield by staking their ETH on Lido and hope to convert their stETH back to ETH when the new Ethereum network standard Ethereum 2.0 is adopted post Merge. Betting on The Merge has long been considered a sure thing as it's felt like Ethereum 2.0 was around the corner for months now. Unfortunately due to multiple delays, the rollout of Ethereum 2.0 has practically become a meme prompting many to ponder the big question “Wen Merge?”
The arbitrage opportunity:
While stETH and ETH should trade at a 1:1 parity, the market turbulence of the last few months has resulted in fears of a potential crypto liquidity crisis. Many holding staked Ethereum were justifiably panicked about market conditions and began dumping their stETH tokens out of fear that there may not be enough ETH available to redeem from Lido in the event of a bank run. This has caused the value of stETH (currently $1,315 on Lido) to become depegged from the value of ETH ($1,344). Herein lies the arbitrage opportunity that many degens are betting on. With staked Ethereum trading at a discount, those who are loading up on stETH tokens are effectively betting on The Merge and stand to make significant gains when Ethereum 2.0 is finally deployed. Not only will stETH holders earn staking yields, but they will also automatically arbitrage the difference in value between stETH and ETH as the two tokens will again trade at a 1:1 ratio post Merge.
What is at stake?
There are some serious risks involved in betting on “The Merge”.
- With numerous delays already, many are justifiably concerned about if and when The Merge will actually happen. The Merge has already been delayed 6 times with the most recent occurrence happening back in June when the “difficulty bomb” was pushed back to August 2022.
- With so many crypto firms like Luna, 3AC, Celsius, Voyager, and Vauld declaring bankruptcy over the last few months, there are concerns about the viability of Lido Finance. Lido has become a market leader in the crypto space for offering users the ability to exchange ETH for stETH. Lido currently accounts for 31.5% of deposits on Beacon Chain with more than 4.1 million ETH locked up in Lido’s smart contracts — approximately $4.4 billion at today’s prices. However, with the market volatility of the last few months, many of the aforementioned bankrupt crypto firms have had to liquidate their stETH positions causing the depeg from ETH that many are trying to arbitrage. The interconnectivity of crypto firms has on multiple occasions resulted in a chain reaction. When a major firm like 3AC collapses, there is the potential for the contagion to take down other firms. Some have referred to this chain reaction as the Web 3 domino effect. It is unclear if Lido will be able to withstand the Web 3 domino effect and survive until Ethereum 2.0 is deployed.
- Finally, it is worth considering macroeconomic conditions and the potential implications for the crypto market. Those who are buying up stETH are assuming markets will go up or at least remain stable. There is the possibility for ETH to tank further by the time The Merge happens and could negate any potential gains from the arbitrage opportunity. This is unlikely but then again we saw 3-digit ETH this year so anything is possible.
Ethereum 2.0 presents a massive opportunity for the bold and ambitious. Those who are loading up on stETH have a potentially massive upside when The Merge finally takes place. The market for high-end graphics and mining cards is already seeing deep discounts as demand is drying up in anticipation of Ethereum transitioning from proof of work to proof of stake. Despite the numerous delays, many are bullish on the notion that we could see The Merge happen this year. If that turns out to be the case and market conditions have improved by then, people who have bet on The Merge stand to make significant returns from the stETH arbitrage opportunity. Until then we need to have faith and keep tweeting “Wen Merge?” — like a text prayer for the entire Web 3 industry. Amen.
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Sources:
https://decrypt.co/105258/how-ethereum-stakers-on-lido-finance-are-trading-the-merge
https://ethereum.org/en/upgrades/beacon-chain/
https://news.coincu.com/98140-ethereum-breaks-promise-the-merge-delayed/
