- If the Ethereum validator output queue becomes congested, Lido may not be able to exchange stETH for Ether during this time.
- stETH holders must then rely on existing liquidity to sell their tokens.
- A lack of liquidity for Lido’s stETH token could cause it to decline during a period of extreme market volatility.
Earlier this year, legacy crypto lender Celsius announced that it would withdraw $1.6 billion worth of Ether that it had previously staked on-chain.
This move instantly clogged Ethereum’s staking withdrawal queue, so that no other Ether stakers could execute withdrawals.
For most punters, waiting a few days to withdraw their Ether is only a minor inconvenience.
But according to some analysts, such a delay could become a major problem for Lido and stETH – the largest liquid staking token Ether with over $23 billion in circulation.
Stay ahead of the curve with our weekly newsletters
“The decline in stETH liquidity is a serious problem,” said Riyad Carey, an analyst at crypto research firm Kaiko. DL News.
The fear is that with low liquidity levels and a clogged exit queue, stETH, which acts as a receipt on staked Ether deposits, could once again break its peg with Ether, causing massive liquidations among those who mine the token on lending protocols.
While there was no depeg this time around, many fear that if the crypto market experiences another sudden downturn, Ether’s milestone queue could quickly grow as the Investors are rushing to unlock their Ether and cash out.
Lido maintains that stETH is sufficiently liquid and that there are mechanisms to prevent further decline.
Join the community to receive our latest stories and updates
But as stETH becomes ever more closely tied to the broader DeFi ecosystem, the threat posed by a potential liquidity crisis only grows.
Not enough liquidity
According to Lido data stETH Liquidity Dune Dashboardthere is currently around $274 million in liquidity on decentralized exchanges.
The head of protocol relations at Lido, Marin Tvrdić, said in a statement recent X post that the liquidity of stETH on centralized crypto exchanges is between seven and eight figures.
Carey argues that the current liquidity of stETH is insufficient.
He says that in situations where the Ethereum validator exit queue becomes crowded, there is not enough liquidity to support the more than $3 billion in leveraged bets on stETH on the DeFi lending protocol Aave, should these positions suddenly unwind.
With the validator queue clogged, Lido has no immediate way to convert stETH to Ether. This means that it is up to the trading pools that facilitate trades between stETH and Ether to take over.
If stETH begins to move away from its peg due to a demand imbalance, this could trigger a cascade of liquidations on Aave. “If a large stETH holder gets impatient and sells, things could go wrong,” Carey said.
And Carey isn’t the only one worried.
Ariah Klages-Mundt, co-founder of stablecoin protocol Gyroscope, said there is a “high probability” that stETH will decline in the future.
“Don’t be too surprised if it happens at some point. Things like this are to be expected to happen at some point in finance,” Klages-Mundt said in a statement. recent X post. Several other Ethereum thought leaders have shared similar viewsalthough not all of them specifically listed the Lido stETH.
Leveraging stETH on lending markets like Aave is a popular DeFi strategy to increase returns. Investors deposit stETH on Aave and borrow Ether, which they then deposit on Lido, thus receiving more stETH.
Repeating this loop worsens the yield of staking on stETH, but also risks liquidation if the stETH collateral loses value relative to the borrowed Ether.
A solid track record
Yet not everyone agrees that Lido’s current liquidity levels are a concern.
Adcv, a pseudonymous contributor to the Lido DAO, said DL News It is “inaccurate” to say that stETH liquidity is insufficient “in light of on-chain evidence.”
“StETH has institutional-grade liquidity, both on- and off-chain across major mainnet trading platforms, Layer 2 AMMs, and major CEXs,” Adcv said.
To support its claims, Adcv highlighted Lido’s strong track record of stETH redemptions.
Of the 3 million Ether withdrawn from Lido since withdrawals enabled by last year’s Shappella upgrade, fewer than 30,000 took more than 120 hours to process, he said.
Aave, on the other hand, defers to the judgment of DAO service providers such as Chaos Labs and Glove to assess the risks associated with the possibility for its users to mine stETH.
In November, Chaos Labs proposed that Aave could increase the supply cap on stETH deposits by an additional 1.1 million tokens “without introducing any significant risk to the protocol.”
But the recommendation, which was also supported by Gauntlet, came with a caveat: Chaos Lab’s risk calculation assumed that there were no significant price divergences between Ether and stETH.
According to Carey, Lido’s liquidity issues began when it stopped offering LDO token incentives to liquidity providers to its stETH-ETH pool on Curve Finance.
Lido stopped encouraging liquidity because Ethereum’s Shella upgrade in April allowed investors to start withdrawing their Ether from the blockchain’s staking contract.
This meant that instead of having to rely solely on the liquidity of stETH on exchanges, Lido could swap stETH for Ether in the event of a supply imbalance.
Lido’s own data shows that since the Shappella upgrade, stETH liquidity on Curve Finance has increased from around $800 million to $274 million.
According to Carey, Lido could do more to shore up its liquidity.
“I wrote in July that I thought Lido should consider engaging with a market maker to help increase off-chain liquidity,” he said. “While off-chain liquidity has improved since then, I think it would still be worth exploring.”
It appears that Lido is looking for ways to further secure the liquidity of stETH.
In August, crypto analytics platform Glass Markets posted a proposal on the Lido Research Forums requesting a grant to assess the liquidity of stETH and write a research report outlining how best to address its recommendations.
A December post from a member of Lido DAO’s operational working group confirmed that Glass Markets had received funding to continue the research report.
DL News contacted Glass Markets and Lido to ask about the status of the research report, but did not receive an immediate response.
Tim Craig is DL News’ DeFi correspondent based in Edinburgh. Contact us with advice at firstname.lastname@example.org.