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How can the stETH depeg be an interesting opportunity?

June 24, 2022
in Ethereum, News
How can the stETH depeg be an interesting opportunity?

In the last few weeks, the Lido stETH price has lost its parity with the Ether (ETH). While it is supposed to trade at the same price, it is now only trading for 0.95 ETH. What has happened? Is this an investment opportunity? If so, what are the associated risks?

What is Lido Finance’s stETH?

Although Ethereum (ETH) has not yet made its long-awaited Merge – i.e. the transition to a blockchain evolving on a Proof-Of-Stake consensus – it is already possible to store Ethers in Ethereum 2.0 smart contracts.

The interest is to be able to generate returns, of the order of about 4% annualized. However, each locked Ether can only be recovered a few months after the Ethereum Merge, which is problematic for users wishing to retain liquidity.

Faced with this problem, Lido Finance offers an interesting solution. The protocol allows users to lock ETH into Ethereum 2.0 smart contracts and receive in return an equivalent in stETH tokens. In addition to offering annualized staking returns, these can also be used in various DeFi protocols to generate returns or deposited as collateral.

In other words, the stETH is a token that certifies that a user has staked ETH in Ethereum 2.0. Thus, for every stETH in circulation, Lido has the same amount of ETH in its reserve. As a result, a few months after the Ethereum Merge, stETH will actually be able to be exchanged 1-for-1 for Ether.

stETH loses its parity to ETH

With the recent Celsius affair, stETH has suffered some very bad publicity. With the platform being blamed for mismanagement of its clients’ assets and overexposure to stETH, many people have been blaming stETH.

Still, the price of stETH has been detached from that of Ether. At the time of writing, one stETH is now traded for only 0.95 ETH. However, this is only the secondary markets, as Wil, an expert and fundamental analyst, explains on our private group the Grille-Pain:

“The fact that one can currently trade 1 ETH for 1.05 stETH is a loss of Peg due to their trading asymmetries in the secondary market. The pair is subject to supply and demand.”

Quite simply, following the Celsius case, many investors panicked and wanted to sell their stETH, causing the price to fall. In reality, as explained above, Lido still has one ETH in its coffers for every stETH in circulation.

Furthermore, at the time of writing, the liquidity pool on Curve is completely unbalanced. Instead of being made up of equal parts ETH and stETH, the distribution is heavily weighted towards stETH, occupying 79% of the pool.

Depeg, opportunity or risk?

The fact that stETH has depegged from ETH stems from a negative sentiment surrounding the product, exacerbated by the Celsius affair. The fall in its price only occurs on the secondary markets and depends only on the law of supply and demand. In this case, there are many more sellers than buyers.

However, as we have already explained above : Lido insures each stETH with one ETH in reserve. This means that once the Ethereum 2.0 smart contracts are unlocked, stETH holders will be able to exchange them for Ether at a 1:1 ratio.

In other words, some investors see this as a bargain: buy stETH at a 5% discount to the Ether price, to get the same amount back in Ether in a few months. But what are the risks?

  • The stETH continues its depeg: this is only a minor risk and is not so impactful. Indeed, each stETH will continue to be worth one ETH in a few months, regardless of the price on the secondary markets;
  • Postponement of the Merge: if the Merge of Ethereum is postponed again, it is possible that users will need their liquidity and will be forced to sell their stETH at a loss to remedy this;
  • Targeted attack on smart contracts: this risk is obviously present in all of decentralized finance and also looms over Lido contracts.

While this strategy may be interesting, it carries undeniable risks. Moreover, as the market trend is decidedly bearish, it is better to remain cautious and to do thorough research before investing part of one’s capital in a financial product.

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