As cryptocurrency markets swooned in recent weeks, large institutional crypto investors including Alameda and Three Arrows Capital have used the blockchain protocol Curve to dump their holdings of a token known as staked ether (stETH). The urgency came because the price of the stETH tokens unexpectedly deviated from a supposed peg to the price of ether (ETH) – the bigger, better-known native cryptocurrency of the Ethereum blockchain, which is the second biggest overall after Bitcoin.
Now, however, the so-called liquidity pool in Curve that the investors used to get rid of their stETH is quickly drying up, a dynamic that might force future sellers into less-transparent over-the-counter markets where discounts might be even steeper.
The pool in question on Curve lets investors exchange stETH to ETH. Since early May, its total value locked (TVL) – a common way of measuring the size of these protocols in decentralized finance – dropped to $621 million from $4.6 billion, data shows. It is also heavily imbalanced, holding almost five times as many stETH as ether, making it expensive or impossible to swap large amounts of tokens.
“I feel badly for retail holders, because the Curve pool has been their only way out,” Vance Spencer, co-founder of venture capital investment firm Frameworks, told CoinDesk in an interview. “Institutions still can get their way out of this with over-the-counter (OTC) deals, although at a significant discount, much higher than in the Curve pool.”
The discount on stETH has been in analysts’ spotlight as a telling sign of the recent liquidity crisis in crypto markets. One stETH represents an ETH token locked up on Ethereum’s new blockchain, called the Beacon Chain.
During times of high inflation and aggressive rate hikes, investors prefer holding “liquid” assets that can be easily sold. The problem is that the tokens locked up on the Beacon Chain cannot be redeemed in the foreseeable future, until six to 12 months after Ethereum successfully completes a much-anticipated upgrade to a “proof-of-stake” network, often referred to as the Merge. And based on the latest estimate from top Ethereum officials, the Merge isn’t expected until August at the earliest.
Chase Devens, analyst at blockchain data platform Messari, wrote in a note earlier this week that “stETH is in the early stages of its natural price discovery,” and the discount “will likely close when staked ETH is unlocked on Ethereum’s Beacon Chain.”
Large holders flee
Until last month’s implosion of the Terra blockchain, stETH traded at a one-to-one ratio with ether. But then, a 2-3% gap between prices opened up. The gap further widened to 5-6% by early June in the wake of the financial troubles of crypto lender Celsius and hedge fund Three Arrows Capital – both major holders of stETH.
“The transparency of the positions of Celsius and Three Arrows Capital had put those firms at a disadvantage in the sense that short sellers knew how much to attack certain assets to try and cause liquidations,” Lex Sokolin, head economist and global fintech co-head at Ethereum developer ConsenSys, told CoinDesk in an email.
Consequently, some large holders dumped their stETH to get ETH, mostly using the Curve pool. Data by Kaiko showed that the stETH-ETH Curve pool was responsible for 98.5% of all decentralized exchange trading volumes in stETH in the last few months, while trading on centralized exchanges was negligible.
Amber, a crypto investment platform, pulled out $160 million within days in early June, according to the Kaiko report. Alameda Research, a digital asset trading firm, sold $88 million in stETH. Three Arrows Capital, the hedge fund that faces a potential insolvency, redeemed about 400,000 ETH and stETH tokens from the protocol in May.
“The reason liquidity providers left is that once the peg broke, they got a terrible deal in that they were selling ETH too cheap,” said Bob Baxley, chief technology officer of automated market maker Maverick Protocol. “As the pool became imbalanced, they did not want to get trapped only holding illiquid stETH.”
As a result, the Curve pool has lost 85% of its value, and holds roughly 111,000 ETH and 492,000 stETH, an indication that many more investors want to sell stETH for ETH than the other way around.
Investors are trapped
Celsius, a big crypto lender now under keen scrutiny since it halted withdrawals citing “extreme market conditions,” might be trapped with its stETH holdings.
Celsius still holds at least about 409,000 stETH, worth about $413 million at current prices, according to data provided by Ape Board, a portfolio tracker from the blockchain analysis firm Nansen.
The stETH-ETH Curve pool only has about 110,000 ether, meaning there’s simply not enough tokens to swap stETH into.
“Celsius couldn’t have sold all of their stETH on centralized or decentralized exchanges, and as a result likely had or will have to resort to an OTC-type transaction in an effort to remain solvent,” Kaiko’s Ryder wrote in the note.
Average investors who want to get rid of stETH may have even fewer options, since they typically cannot access over-the-counter markets to strike a deal.
Centralized exchanges don’t have enough market depth for the stETH-ETH trading pair for those who want to sell, the Kaiko report showed.
The only way out left for retail investors is the Curve pool, which has been rapidly shrinking by 10,000-15,000 ETH a day this week.
Assuming that rate continues, the pool would be fully drained within two weeks.