The crypto market is collapsing, and certain companies taking big risks are facing consequences.
Celsius, one of the largest DeFi lending platforms with about $12 billion in assets under management, announced on Sunday that they would suspend all withdrawals, sparking widespread investor panic that the company was “insolvent.”
There have also been rumors in the past two days that Three Arrows Capital (3AC) is struggling for solvency. How on earth did the big institutions intertwined with the biggest market players end up in a Lehman-like end?
Poor asset management, bearish market conditions and Ethereum’s derivatives have combined to create a storm with disastrous consequences.
Let’s take a look at how Ethereum’s liquidity derivative token, st ETH , is causing billions of dollars in liquidity problems through data.
What is stETH?
Later this year, the Ethereum mainnet will complete the Merge process, transitioning from Proof of Work (PoW) to Proof of Stake (PoS). Prior to the merger, investors could stake ETH to secure the new PoS chain, or earn yield for themselves. However, this gain comes at the cost of illiquidity, as stakers cannot redeem their staked ETH until the network completes the transition, and more skeptics worry that the merger may not even be completed this year. In order to become a validator on the new chain, staking directly through Ethereum also requires a high threshold of 32 ETH.
So, some small investors are starting to enter Lido Finance: a decentralized staking platform designed to provide a liquidity solution for ETH staking. Lido provides a 1:1 derivative token with ETH, stETH (without the 32 ETH requirement), and also provides similar benefits to staking directly on the PoS chain (about 4% APR). After the Ethereum merger is completed, the ETH (stETH) pledged in Lido can be fully redeemed through Lido, providing pledgers with all the benefits of staking in the PoS chain without the disadvantages of insufficient liquidity and high barriers to entry. stETH can also provide other functions such as lending, staking (yes, you can secondary stake stETH) and trading.
Today, more than 4 million ETH is staked on Lido, making it the largest single staking service, accounting for about 32% of all staked ETH.
stETH liquidity pool
To support the growing demand for stETH, decentralized exchange Curve has introduced liquidity pools for the stETH-ETH pair so that investors can easily convert their ETH to stETH at a reasonable price, or liquidity pools provide liquidity , and earn income in the form of CRV tokens.
However, the rapid rise of Lido/stETH and the collapse of Terra have caused some problems with the stETH-ETH exchange rate. In May, stETH started trading at 5% less than ETH, sparking initial concerns. This discount resurfaced last week, sparking the start of Celsius’ liquidity problems.
As Terra collapsed, investors started flocking to Ethereum and discounts on stETH began to appear. stETH is a derivative of ETH, so it is not very liquid across the market, which has led investors to panic swap their stETH for ETH, withdrawing ETH from the Curve liquidity pool, and causing inconsistencies between the two assets. balance. The pool is currently the most unbalanced ever, roughly 80% stETH and 20% ETH.
Behind the stETH discount: a liquidity hit
Unlike TerraUSD (UST), stETH does not need to maintain its peg. stETH is simply a 1:1 token representation of the amount of ETH a user has staked in Lido. As a decentralized staking service, Lido had to honor the combined stETH redemption.
Hence, the issue with the stETH discount is focused on liquidity. Under normal market conditions, the stETH-ETH liquidity pool enables efficient exchanges between assets, allowing stakeholders to easily cash out ETH when they want to withdraw from stETH.
Only a combination of discounts and poor market conditions caused serious problems for a protocol like Celsius that manages money on behalf of clients. Celsius users have increasingly sought to redeem ETH after the extremely bearish price action last month and news of their possible exposure to Terra became public. However, it is clear that Celsius will have difficulty meeting these redemption requests due to the lack of liquidity in its stETH holdings.
While it’s not entirely clear how much ETH held by Celsius was converted into stETH, it’s estimated to be around $475 million, according to public wallet information provided by Dune Analytics. The platform has since halted all withdrawals, all but confirming investor concerns.
Despite being fully centralized, Celsius has its own token — CEL — as a reward for platform users. The CEL perpetual contracts market reacted almost immediately to the announcement, with soaring open interest and plunging funding rates, suggesting investors were adding to their short positions, anticipating a full-blown Celsius meltdown.
The price of CEL has been battered since the beginning of the year due to a generally bearish market, but after the announcement the price plummeted to just $0.17.
The market’s reaction to the CEL token means Celisus has to deal with solvency issues. What options do they have?
1) Wait for Ethereum to merge and convert stETH to ETH 1:1
This is clearly not an option for Celisus or any other institution facing solvency issues. This is why the stETH discount only really matters if you need instant liquidity, if you are a long-term holder of stETH then you won’t care about the discount as you can get a one-time 1 after the Ethereum mainnet merge is done :1 exchange.
2) Sell stETH on the open market and repay the redemption
If you need liquidity, the first point is to check whether selling stETH on the open market is an appropriate option. First, let’s look at the decentralized exchange Curve, as it has by far the most liquid stETH market.
May 18, 2022:
June 15, 2022:
Today, there is only 116,000 available ETH (~$130 million) available to sell stETH, and if Celisus sells here to get the liquidity it needs, it will definitely cause the exchange rate between stETH and ETH to collapse. We can see in the graph above that a month ago, liquidity was more accessible, with 291 million ETH available in the Curve pool.
For example, selling 100,000 stETH on Curve for ETH would result in an exchange rate of just 0.84 (which is only 1/4 of the total Celisus holdings).
Next we can see if selling stETH on a centralized exchange is an option.
We can look at the market depth of FTX, the only stETH spot market on centralized exchanges, to see if there is enough liquidity to support a large number of stETH sell orders.
We can clearly see that without reducing the price of stETH, FTX’s market depth is nowhere near the order of magnitude required for Celisus.
Using 2% market depth as a measure of stETH liquidity available to centralized exchanges, we observed only $300,000 worth of stETH liquidity on FTX prior to June 11. But after the Celisus fear swept the market, that number dropped to less than $50,000, and stETH holders have now nearly exhausted all the available stETH liquidity they could find on centralized exchanges.
To illustrate the loss of just selling $100,000 worth of stETH on FTX, I plotted the slippage of the stETH-USD pair on the exchange, and we can see that selling just $100,000 worth of stETH on FTX has already becomes completely infeasible. The pair’s slippage has increased to 3.5%, which, combined with the roughly 5% discount on stETH to the price of ETH, means that selling stETH on a centralized exchange results in an 8.5% loss on a $100,000 order book.
The spot trading volume we have observed on FTX over the past few days indicates a daily volume of up to $10 million and has since fluctuated between $1 million and $5 million, likely due to a lack of liquidity. Celsius may and may not be entrusting its roughly $475 million worth of stETH to FTX.
Overall, stETH trading activity is dominated by Curve, accounting for 98.5% of the total volume in 2022. Although stETH is also listed on other decentralized exchanges such as Uniswap and Sushiswap, the trading volume and liquidity are nowhere near as high.
Here are some interesting insights from looking at the volume in Curve’s liquidity pools: The exchange of stETH to ETH in liquidity pools appears to be fairly evenly distributed since late May, which may indicate that some investors are happy to trade at the current discount Buy stETH to make a profit when you can exchange ETH 1:1. The amount of stETH sold shows that there are also many desperate sellers willing to accept discounts. While it’s hard to get out with current liquidity conditions, Celsius and 3AC are likely to sell a small amount of stETH to get ETH to pay off.
3) Use stETH or other reserves as collateral for OTC protocols
Clearly, institutions facing solvency issues cannot wait for an Ethereum merger to redeem their stETH holdings, nor can they sell large amounts of stETH on centralized or decentralized exchanges. This really leaves only one option to avoid complete bankruptcy: use stETH as collateral and enter into some form of over-the-counter (OTC) contract with an exchange or market maker.
In the last week, not only did we see the “Extreme Survival” of Celsius and crypto trading platform Amber Group, they were both spotted sending large amounts of stETH and other reserves to FTX. The graph below shows the minting and burning in the Curve stETH-ETH pool, we observed a large amount of burns in both stETH and ETH last week, indicating that liquidity has been withdrawn from the Curve pool in large quantities.
Interestingly, a significant amount of stETH was burnt from the pool, suggesting that users are willing to lock up the stETH discount, either by holding it long-term or by exchanging it for ETH. Looking at on-chain data, we can see that wallets belonging to the Amber Group have destroyed over $150 million worth of stETH from the Curve pool over the past few days. Then Amber Group sends stETH to FTX.
FTX is now the largest holder of stETH outside of smart contracts, after taking massive deposits from Celsius and Amber. As I pointed out before, these deposits never made it into FTX’s spot market because such a large volume of trades was easy to spot.
For me, OTC is the only way to get stETH liquidity returns. The problem with over-the-counter transactions is that they are essentially off-chain and therefore impossible to find. Therefore, we are temporarily unable to determine how these stETH will be handled.
But the Ethereum futures market on FTX does show some interesting trends that may provide some insight. We observed a sharp increase in open interest on FTX, while open interest on other exchanges fell as the price of ETH plummeted. When asset prices crash, we typically observe a drop in open interest due to increased liquidations, the unwinding of futures contracts, and the impact of falling prices on the actual open interest data itself. It’s interesting to see open interest rise in and of itself with FTX prices falling, but the trend is even more interesting when you consider the massive stETH and ETH deposits that exchanges have received over the past few days.
- Celsius can trade OTC with FTX, use or exchange their stETH, and take a short ETH position in the perpetual futures market, and if ETH falls, they can profit by closing the contract at a lower price. Pausing withdrawals gives them the only chance they might be profiting from the position.
- Another guess could just be that FTX or some market maker is taking stETH from Celsius at a deep discount in order to profit when stETH is 1:1 for ETH. They may have used a short position in ETH through FTX to hedge price risk, minimize losses, and ensure that their profits come entirely from the price difference between stETH and ETH.
All in all, what will happen after FTX receives a large influx of stETH and ETH is anyone’s guess. From the data, however, it is safe to say that Celsius cannot directly sell all of their stETH on a centralized or decentralized exchange, and thus may have to use stETH in OTC-type transactions to remain solvent.
Even if they did survive the onslaught, I don’t see anyone else who would trust Celsius to keep their assets safe. Maybe a few years from now, we’ll see this as a watershed moment for adoption in the DeFi space.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/behind-celsius-insolvency-eths-liquid-token-becomes-less-liquid/
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