How serious is the risk of stETH as institutions withdraw from Lido?

Is there any way for small retail investors to make a profit?

Original author: CryptoJoe (founder of Rebirth DAO, senior trader)

Original translation: czgsws, BlockBeats

stETH was depegged and its value dropped to 0.95 ETH.

Liquidity is drying up, Smart Money is withdrawing funds, and coupled with rumors that lending platform Celsius is on the verge of bankruptcy, all of this could trigger a massive sell-off of stETH. Messari analyst @Riley_gmi and I have been looking into this recently, and here are some of our findings.

First of all, what is Lido & stETH?

Lido provides users with ETH liquidity staking services. Users can lock any amount of ETH and then receive the equity Token stETH to earn income in DeFi .

After the merger, each stETH can be normally exchanged for 1 ETH.

Each stETH can only be redeemed through the launch of the beacon chain. Before that, the 12.8 million ETH in the ETH 2.0 staking contract is not liquid.

Lido holds 32% of the 12.8 million ETH (approximately 4.1 million)

Before we dive into Celsius’ balance sheet and track down Smart Money addresses, let’s first look at how stETH should be priced:

As Lido said, stETH is anchored to ETH (on the beacon chain ), and now the market is starting to re-price the fair price of stETH.

But given the liquidity dynamics of this investment, how much of a discount is fair to the price of stETH?

stETH pricing should be determined by the following 4 things

The current market’s thirst for liquidity (demand/supply)

Current market volume and liquidity (how the market is responding to selling pressure)

· Likelihood of successful/delayed merger

Smart contract risks

In detail

1. The degree of desire for market liquidity

The demand for liquidity rises and falls at different stages of the market cycle. When prices rise and liquidity is high, it is easy to close positions and the cost is low, and vice versa.

Through on-chain data, we have seen a large number of withdrawals of stETH, such as the crypto financial service provider Amber , whose wallet address has withdrawn more than $140 million worth of stETH from the Curve pool.

This is a growing trend over the past few days and may be a sign that a larger potential sell-off is brewing.

In this case, the most critical supply and demand side is the crypto lending platform Celsius. If anyone believes that Celsius may be forced to sell a large amount of stETH, then this will greatly change the supply and demand relationship we have previously emphasized.

The key question is how much can the market absorb and at what cost?

So what is the liquidity of stETH?

2. Current market volume and liquidity

Total liquidity in the pool dropped by over 20% early this morning, with a massive sell-off from wallets associated with Alameda Research, which Celsius also mentioned before I posted this.

Amber’s withdrawal of over $150 million in stETH liquidity is significant and is likely just a warning of a sell-off.

That's $150 million, which will likely be released to the market in the coming days.

The second point is that the liquidity pool on Curve has become extremely unbalanced. This imbalance in the capital pool is dangerous and will greatly increase the risk of decoupling.

The withdrawal of liquidity from 3pool on Curve was the first shot that led to the collapse of UST. Less liquidity = more risk.

The point is that given stETH’s closed liquidity structure, many institutions and regular participants are exposed to risks.

Those stETHs that enter the market could deal a significant blow to the market.

3. Likelihood of Success/Delayed Merger

The penultimate risk is the possibility of a delay or even failure of the beacon chain, which will have an impact on stETH. As some KOLs have pointed out, stETH is similar to ETH futures.

In this sense, if the merger is delayed and it takes 6-12 months after the merger to get back the ETH, locking up the tokens will increase the liquidity cost, which is far greater than the benefits gained during this period.

4. Smart Contract Risks

Putting aside demand/liquidity/merger risks, there is also smart contract risk.

Based on the insurance cost of the Lido deposit contract on Nexusmutual (which is 2.6%), pricing is pretty straightforward.

Therefore, the smart contract risk ALONE (minimal risk) in stETH is at least 2.6%, which is roughly the current discount of stETH/ETH.

This shows that the risk of stETH is seriously underestimated.

A similar case to stETH pricing is GBTC, as they are both closed.

If you want to sell your GBTC position, you have to sell it on the secondary market since it is a closed-end fund. Before it converts to an ETF, the secondary market is the only option for liquidity.

If you want to sell your stETH, you must do so on the secondary market until the merger.

In both cases, this liquidity, open-ended risk, and supply and demand dynamics are the underlying factors that influence the market fair value of the asset.

But in this case, why is one trading at a 3% discount and the other at a 30% discount, not to mention that stETH also has the factor of Lido’s smart contract risk.

Lido’s seven investors have created a similar situation to UST: a16z , Alameda Research, Coinbase , Paradigm, DCG, Jump Captial, and Three Arrows Capital.

Similarly, Blockfi, one of the largest holders of GBTC, currently has a floating loss of nearly $500 million.

This has been reflected in Blockfi's valuation. BlockFi is conducting a new round of financing with a valuation of US$1 billion, while their valuation was US$3 billion in March 2021.

What’s the point? Many of the big players in the game are often wrong, and in this case, they completely miscalculated the liquidity costs of GBTC and stETH, both of which were liquidity black holes in this case.

So ultimately, we think that the one-year staking yield for this liquidity trap is too low.

Maybe the number should be similar to GBTC, at 30%, but not 3%.

Now, let's look at what's happening in the market right now:

Liquidity has been drained out and whales and smart money are selling.

The amount of stETH held by smart money addresses dropped from 160,000 stETH to 27,800 stETH in 1 month.

In fact, Alameda dumped 50,615 stETH into the market within 2 hours on Wednesday.

It is very likely that someone is deliberately pulling the peg towards the liquidation price of stETH.

Leveraged stETH holders will face the risk of liquidation if they do not have sufficient collateral.

For example, when stETH=0.8 ETH, $299 million will be liquidated.

Emphasis on the short term here. I ultimately believe people will be happy to buy stETH at a discount. However, the situation will change slightly when some institutions have to sell.

The institution that may have to sell is Celsius.

By performing on-chain analysis, I was able to calculate Celsius’ assets and liabilities.

Total assets are $3.48 billion, loans are $1.11 billion, and net assets are $2.374 billion (assuming Celsius holds 45% of its CEL Token supply, worth about $100 million).

A full breakdown of the holdings is as follows:

*Note, this is only their assets in DeFi, no one knows what crypto assets they hold elsewhere (e.g. in CEX).

They claim to have around $10 billion in TVL, but that’s all I could find.

The important part here is that Celsius is a whale holder of stETH. In fact, they are the largest interest-bearing stETH holder (on AAVE).

If we analyze Celsius’ ETH holdings specifically, we find that 71% of them are illiquid or low-liquidity.

$510 million worth of ETH is locked in the ETH2.0 staking contract and cannot be taken out until after the merger.

$702 million is in stETH and cannot be easily exited through liquidity pools.

What happens if a Celsius user wants to redeem their money?

Are they redeeming?

Why did they activate HODL mode on their accounts?

On October 8, 2021, Celsius reported that its AUM exceeded $25 billion. Celsius is a private company and has only released its financial data for 2019 and 2020. Despite repeated calls from investors on various social platforms for them to release new financial data, they did not release new financial data for 2022.

The company also did not publish an audit report. They did in '19 and '20, but not in '21.

On December 20, 21, they released a report in collaboration with Chainanalysis, which confirmed that since its launch in 2018, users have deposited more than US$7.609 billion on the platform and withdrawn more than US$4.29 billion.

According to the report, Celsius had $3.31 billion worth of on-chain assets on December 20.

The company reported administrative expenses of $35 million, 40% higher than its cost of sales.

The lack of transparency has investors concerned about the possibility of a run on Celsius.

The company currently holds liabilities in stablecoins rather than taking positions in ETH, BTC, and LINK, which exposes them to market risk of downward cryptocurrency prices.

If the market crashes, they will face a debt crisis.

After the Terra crash (May 6-12), there was $750M in outflows (150M ETH and $150M BTC).

In the last two weeks of May, the company had net outflows of $450 million.

Even if we ignore the week in which no outflows were reported, Celsius experienced a total of $1.2 billion in outflows.

Such outflows increase the risk of a run on Celsius.

The chart below shows the outflows over the past 5 weeks. The total withdrawals over the past 5 weeks are 190k ETH.

Compare this to the previous 5 weeks, when Celsius had 50k inflows.

Celsius has been experiencing massive withdrawals from its ETH and general assets.

Currently, they have enabled “HODL mode” which prevents users from withdrawing funds from Celsius.

Another problem with Celsius is that only 29% of Celsius’ ETH is liquid:

1. Liquid ETH

Most ETH is deposited into AAVE (150k ETH) and COMP (45k), with both positions collateralized by assets at around 45% LTV.

They must repay the loan before they can withdraw their ETH.

2. 458k ETH in StETH

The liquidity pool on Curve, st-ETH and ETH are highly unbalanced, with only 250k ETH to 642k stETH. If Celsius were to exchange all St ETH, they would only get 250k ETH.

3. 324K ETH has been deposited into the ETH 2.0 contract. Celsius will not be able to obtain this ETH for at least 1-2 years.

- 158K of which were obtained through Figment.

- The remaining 166,400 was obtained through the Ethereum Foundation ETH 2.0 contract.

Additionally, they lost $70 million in the Stakehound incident.

(BlockBeats Note: On June 7, according to Dirty Bubble Media, the crypto lending platform Celsius Network lost at least 35,000 ETH in the Stakehound private key loss incident.)

Then another $50 million was lost in the BadgerDAO theft.

In addition, $500 million in customer deposits were wiped out in the recent LUNA crash.

So how can you trade to profit in this situation?

We have seriously considered it and contacted market makers, and also searched DeFi. You need to find a place to borrow stETH before you can sell it, and there is no relevant contract, so it is a bit difficult to make money from it.

There are two main ways to do this.

1. Over-the-counter market.

If you are a large institutional player, you will have access to market makers and brokers who can lend you stETH against your ETH collateral.

This is impossible for 99% of market participants.

2. Euler finance

You can deposit ETH and borrow wstETH at a 4% holding cost to sell on Curve, Uniswap , or 1inch .

The profit/loss ratio of the trade is very good because the biggest cost is that the ETH returns to the peg and you have to repay the loan; this is about a 5-6% loss.

Similar to UST, given the limited upside risk of stETH exceeding a 1:1 value with ETH, this is a cheap way to bet on the market.

Another way to profit from this trade is to buy stETH at a discount. If stETH is trading at a larger discount than GBTC (30%) and there are forced sellers in the market like Celsius and others. To us, this feels like a good opportunity to convert any ETH holdings into stETH.

Another way to profit from this trade is to buy stETH at a discount. If stETH is trading at a larger discount than GBTC (30%), and there are institutions in the market that have to sell (like Celsius or others). To us, this feels like a good opportunity to convert any ETH holdings into stETH.