Tempus Takes #6
Is your Lido safe from tsunami?
One thing we all learned from the recent crypto tsunami is that there are no unbreakable pegs.
On 6 May, stETH stopped trading at 1:1 against ETH.
Source: Coingecko
Background
Ethereum is transitioning from PoW (Proof of Work) to PoS (Proof of Stake); the end state is more commonly known as ETH 2.0. PoS offers staking rewards, currently between 4–5%. In order to run the PoS during the transition, at least 32 ETH must be staked with a validator software running continuously on one’s computer.
As there is a minimum of 32 ETH and ongoing node maintenance, there is a high barrier to entry for many people, a protocol called Lido came out with a pooled solution.
Lido is a liquid staking solution to address the above needs. It allows users to:
- stake any amount of ETH on their platform;
- without the hassle of maintaining their own infrastructure;
- offering a freely tradable stETH staking token;
- in exchange for a 10% cut of the staking rewards.
The staking rewards are paid daily in the form of additional stETH. Hence, if you ignore the locked nature of stETH, one stETH is as good as one ETH.
When Ethereum’s beacon chain completes and withdrawals are enabled, staked ETH can be converted back to ETH.
Although stETH is not required to peg 1:1 to ETH, such peg helps stETH’s stability and attracts more capital, hence fees for Lido. Thus, Lido has been supporting a 1:1 stETH to ETH pool on Curve (with massive incentives in the form of LDO tokens), earning swap fees at the same time. This design has allowed Lido to grow massively since inception.
Evolution
As people grew used to stETH:ETH’s 1:1 exchange rate and started taking the peg for granted, platforms such as AAVE started accepting stETH as collateral (LTV = 73%, Liquidation Threshold = 75%).
As the peg implies low risk between the collateral and borrowed asset, many people used loops to add significant leverage to their position, converting the original 4% APY to near 10% APY.
Many of the stETH also ended up on Terra’s Anchor, as one can post stETH as collateral to borrow and deposit UST for a higher return.
Tsunami
As Terra collapsed, investors closed their UST positions and withdrew stETH out for safety.
The Curve stETH/ETH pool had around 1.6m coins (~$5bn) inside before the tsunami, which was safe. But it was not enough when Terra collapsed and the broader market fell with it.
The depeg in itself does not break ETH’s staking function. But for someone leveraged with a LTV ratio of 0.73 and 0.75 liquidation threshold, a 2.7% (1–0.73/0.75) depeg means a potential liquidation of their position, which could have severe spillovers on the broader market.
Lido officially sent out a warning for this on 14 May. As the stETH/ETH pool was drained, Lido acted quickly to come out with a Curve concentrated pool with 1 million LDO tokens as an incentive in the following week. A new vault on Yearn also came online at the same time, providing the market with additional liquidity to ensure that stETH’s fall is stopped.
At the time of this publication, stETH is trading at 2.0% discount.
Takes
Unlike UST which is algorithmically backed by LUNA which can be unlimitedly minted, stETH will be fully convertible to ETH (limited circulation) when the beacon chain is live, hence its value relative to ETH should hold — it’s just a matter of time.
The fast and transparent decentralised reaction by Lido with Curve and Yearn is also a positive contrast to Terra’s opaque centralised actions.
Our view is that, in the short term, stETH’s volatility might persist, but in the long term the peg is mostly safe.
Market Move
Versus 2 weeks ago, yields have lowered on Ethereum and increased on Fantom.
In the last week, we have also updated the fixed rate APRs shown on our website. Historically, the APRs shown on our website were assuming a holding period of the whole pool’s duration. As not all users join the pool at the beginning, to better represent a new investor’s return, we have amended the display calculation to reflect the true return between now (last block’s update) and the pool’s maturity.
As a result, you will find our current fixed rates are actually super attractive per the table below.
Disclaimer
The information provided in this article is provided for informational purposes only and does not constitute, and should not be construed as, investment advice, or a recommendation to buy, sell, or otherwise transact in any investment, including any products or services, or an invitation, offer, or solicitation to engage in any investment activity. You alone are responsible for determining whether any investment, investment strategy, or related transaction is appropriate for you based on your personal investment objectives, financial circumstances, and risk tolerance. In addition, nothing in this article shall, or is intended to, constitute financial, legal, accounting, or tax advice. We recommend that you seek independent advice if you are in any doubt.