It’s only been a month since the collapse of Terra, and the chaos that it created in the crypto market, and now Lido Finance and its Staked Ethereum (stETH) are at the center of another potential liquidity crisis.
Crypto lending company Celsius is one of Lido’s principal clients and, as such, one of the largest holders of stETH. The problem? Staked ETH is always supposed to be worth 1 ETH—and it hasn’t been for some time now.
Staked ETH represents Ethereum that’s been locked up on the Ethereum 2.0 beacon chain—a network that will soon be merged with the Ethereum mainnet in a highly anticipated upgrade that transitions the blockchain to proof of stake. Normally, users would need a minimum of 32 ETH (worth roughly $40,000) to participate in ETH 2.0 staking and earn rewards. But Lido Finance makes it possible for users to stake any amount of ETH. And because it’s “liquid staking,” it gives users stETH tokens in return.
That stETH can then be lent, staked, and traded for other tokens.
Celsius does precisely that with its own clients' funds. But now, a day after Celsius paused customer withdrawals, swaps, and transfers—”to put Celsius in a better position to honor, over time, its withdrawal obligations,” the company said—there’s growing concern over the lending company’s exposure to stETH.
The company has at least $475 million worth of stETH in a public wallet, according to blockchain research firm Nansen Research.
Celsius works by staking customer deposits, in this case Ethereum, in yield generating decentralized finance (DeFi) protocols like Lido. In return, Celsius receives stETH, which increases in value as the deposits earn rewards. Celsius makes money by paying its customers their promised rate of return, recently that’s been between 6% to 8% on ETH deposits, and keeps the rest.
The value proposition for Celsius depositors is that they are promised a fixed rate of return on their ETH and leave it to the company to figure out how to reliably generate that return.
But that strategy starts to come apart if stETH loses parity with ETH (it has) at the same time that there are a lot of Celsius depositors looking to withdraw their ETH (they are) because Celsius doesn’t appear to have enough liquid ETH to meet all of its obligations.
By Monday afternoon, stETH had yet to pull even with Ethereum. At the time of this writing, stETH was trading at 0.94 ETH. stETH has been trading below 1 ETH since last month, when stETH was impacted by the TerraUSD and Luna collapse.
A large public Celsius wallet shows $475 million worth of stETH being used as collateral for hundreds of millions in stablecoin loans.
“They have also sent thousands of stETH to FTX in recent days, presumably to sell,” Andrew Thurman, content lead at Nansen, told Decrypt, “though we can't verify that because it's off-chain. They have likely been especially hard-hit by stETH losing its peg to ETH.”
But selling large quantities of stETH to get more liquid ETH would cause its price to drop even more, which would further compound the liquidity crunch that Celsius is already facing.
There have been efforts to find the other public wallets, and therefore account for the rest of Celsius’s $10 billion in customer assets, but so far only about $1.5 billion appear to have been accounted for, according to research from The Block. That doesn’t mean Celsius doesn’t have that ETH, but it has still caused a panic.
“Celsius has likely failed to isolate risk: they might have taken USDC and held it in UST (Luna's stablecoin), or taken ETH and held it in stETH,” Jack Niewold, founder of crypto newsletter Crypto Pragmatist, wrote in a Twitter thread. “So, when ALL of crypto drops and ALL users want their funds back, ALL Celsius users feel the pinch.”
Celsius did not immediately respond to Decrypt’s requests for comment.
If all the hand wringing over stETH feels familiar, it’s because it also played a role in the collapse of Terra’s UST and LUNA tokens. At the time, the stETH to ETH imbalance was the opposite of what it is today.
Last month, there was a run on stETH because users were rushing to pull their funds out of the Anchor lending protocol on the Terra blockchain, which back then offered users up to 20% returns on their UST deposits. After Terraform Labs shut down the Terra network twice, users cashed out their stETH, pushing the price up.
One ETH could be exchanged for 1.0248 stETH through the Curve protocol, meaning it was trading at a 3% discount relative to Ethereum.
When that happened, it created an opportunity for arbitrage trades. Investors were able to sell stETH for more ETH than had been deposited to create it, which created a big drawdown on Lido’s ETH pool.
Each time there’s a big liquidity crunch, Brian Norton, COO of My Ethereum Wallet, told Decrypt, it makes DeFi feel a lot like traditional finance because it leaves a centralized platform in control of people’s ability to access their funds.
“Every time you see this, every time this just reinforces the point that if you're relying exclusively on these sort of centralized platforms,” he said, referring to Celsius, “even when the yields are great, I think you're still giving up a good deal of control.”
Last week, the Celsius team went to great lengths to assure customers that it could meet its obligations.
“Celsius has the reserves (and more than enough ETH) to meet obligations, as dictated by our comprehensive liquidity risk management framework” the company wrote in a blog post, following rumors that it had been heavily impacted by the Terra crash.
The post ended with a somewhat chilling quote from U.S. Navy Admiral David Farragut, who led an attack on New Orleans during the Civil War: “Damn the torpedoes, full speed ahead.”