What is staked ether (stETH) and why does it cause chaos in crypto?

Another controversial cryptocurrency is causing chaos in the digital asset market – and this time it is not a stable currency.

Inserted ether, or stETH, is a symbol that should be worth the same as ether. But in recent weeks, there has been an increasing discount to the second largest cryptocurrency, which has led to the flames of a liquidity crisis in the crypto market.

On Friday, stETH fell as low as 0.92 ETH, which means an 8% discount on ether.

Here’s everything you need to know about stETH and why it has worried crypto investors.

Each stETH token represents a unit of ether that has been “set” or deposited in what is called the “beacon chain”.

Ethereum, the network that forms the basis of ether, is in the process of upgrading to a new version that is meant to be faster and cheaper to use. The Beacon chain is a test environment for this upgrade.

Staking is a practice where investors lock their tokens for a period of time to contribute to the security of a krypton network. In return, they receive rewards in the form of interest-like returns. The mechanism behind this is known as “proof of effort”. It is different from “proof of work” or mining, which requires a lot of computing power – and energy.

To bet on Ethereum at the moment, users must agree to lock at least 32 more ETHs after the network is upgraded to a new standard, known as Ethereum 2.0.

However, a platform called Lido Finance allows users to bet any amount of ether and receive a derivative token called stETH, which can then be traded or lent on other platforms. It is an important part of decentralized finance, which aims to replicate financial services such as lending and insurance using blockchain technology.

StETH is not a stable coin like tether or terraUSD, the “algorithmic” stable coin that collapsed last month under the strain of a bank run. It’s more like an IOU – the idea is that stETH holders can redeem their tokens for an equivalent amount of ether once the upgrade is complete.

When the Terra stablecoin project imploded, stETH’s price began to trade below ether as investors ran after the exit. One month later, cryptocurrency lender Celsius began stopping bank withdrawals, causing stETH’s value to fall further.

Celsius works a lot like a bank, takes users’ crypto and lends it to other institutions to generate returns on deposits. The company took the users’ ether and invested it through Lido to increase profits.

Celsius has more than $ 400 million in stETH deposits, according to data from DeFi analysis site Ape Board. The fear now is that Celsius will have to sell its stETH, which results in large losses and puts more pressure down on the token.

But that’s easier said than done. StETh holders will not be able to redeem their tokens for ether until six to 12 months after an event known as the “merger”, which will complete Ethereum’s transition from proof of work to proof of effort.

This comes at a price, as it means that investors are stuck with their stETH unless they choose to sell it on other platforms. One way to do this is to convert stETH to ether using Curve, a service that raises funds to enable faster trading in and out of tokens.

Curve’s liquidity pool for switching between stETH and ether “has become quite unbalanced,” said Ryan Shea, an economist at crypto-investment firm Trakx.io. Ether accounts for less than 20% of the reserves in the pool, which means that there would not be enough liquidity to cover each stETH outlet.

“Staked ETH issued by Lido is supported 1: 1 by ETH deposits,” Lido said in a tweet last week, trying to calm investors’ fears of stETH’s growing deviation from the value of ether.

“The exchange rate between stETH: ETH does not reflect the underlying support of your ETH, but rather a fluctuating secondary market price.”

Like many aspects of crypto, stETH has been caught in a whirlwind of negative news affecting the sector.

Higher interest rates from the Federal Reserve have triggered an escape to safer, more liquid assets, which in turn has led to liquidity problems for large firms in the area.

Another company with exposure to stETH is Three Arrows Capital, the crypto hedge fund that is rumored to be in financial trouble. Public blockchain records show that 3AC has actively sold its stETH holdings, and 3AC co-founder Zhu Su has previously said that his company is considering selling assets and rescuing another company to avoid collapse.

Investors worry that the fall in stETH’s value will affect even more players in crypto.

“In crypto, there is no central bank,” Shea said. “Things just have to play out, and that will continue to weigh on the prices of cryptocurrencies, amplifying the negative effects of the macro backdrop.”

Bitcoin fell briefly to below $ 18,000 per coin on Saturday, pushing deeper into the 18-month low. It has since returned over $ 20,000. Ether fell below $ 900 at one point, before taking back $ 1,000 by Monday.

The STETH debacle has also led to new concerns for the safety of Ethereum. About a third of all the ether locked into Ethereum’s beacon chain is invested through Lido. Some investors are concerned that this could give a single player too much control over the upgraded Ethereum network.

Ethereum recently completed a dress rehearsal for its long-awaited merger. The success of the event bodes well for Ethereum’s upgrade, with investors expecting it to take place as early as August. But it is not clear when it will actually happen – it has already been delayed several times.

“The latest updates to Ethereum’s test network have been positive, giving more confidence to those waiting for the merger,” said Mark Arjoon, a research fellow at crypto-asset management firm CoinShares.

“So, when withdrawals are finally activated, any rebate in stETH is likely to be arbitrated away, but until the unknown date comes, there will still be some form of rebate.”