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13th June 2022 > > De-pegging risk.

tl;dr

De-pegging risk should be higher in all our thought processes.


Market Snap (at time of writing)








Market Wrap

That is some carnage in crypto markets.


Occasional Series – Lockdown

“LOCKDOWN has left Year 6 pupils socially and emotionally unprepared for secondary school, say eight in 10 teachers. When they arrive in Year 7, pupils will be unready, teachers have warned, citing fears over behaviour, ability to focus and maths and English skills.”


The Times, 13th June 2022


Curious Cryptos’ Commentary – De-Pegging risk

The recent Terra fiasco (see CCC from 14th May onwards) was instructive on a number of levels.


The most obvious lesson was that algorithmic stablecoins are an essentially worthless idea, a fact that would be immediately transparent to a ten year old child who had not suffered lockdown but was ignored in yet another gold rush scenario that accompanies some crypto developments.


It demonstrated the need for greater transparency by all participants - Do Kwon was reportedly cashing out $80mm per month on average from selling virtual shovels.


Most important of all, it showed that de-pegging risk can have some significant ramifications.


And here we (potentially) go again.


The invention of the ability to move assets cross-chain was a seismic event that will stand the test of time. I am a little unclear as to when this first happened, but the idea of wBTC (wrapped BTC that could be used as an asset on the Ethereum network) first started to enter the lexicon in 2018 or so.


Indeed, all Layer-2 networks that provide high throughput (something that both BTC and ETH deliberately lack in exchange for network security) rely upon the concept of tokenising the currency of the Layer-1 network, whilst relying on the security of that network.


Incidentally, this is why all talk of “ETH killers” in the context of Layer-2 is frankly nonsense spouted by those who know not of what they speak, but that is a subject for a different day’s discussion.


For the very small minority of people who are regular users of Decentralised Finance (DeFi) protocols nomenclature such as wBTC, $FORT, etc. is achingly familiar. For the rest of the population, the addition of a small letter or two, or another symbol in front of the usual 3 or 4 letter acronym for a crypto simply denotes that in some sense, that crypto has been moved to a different network, or a different layer, or maybe just another protocol.


The key assumption made at all times is that both assets can be exchanged 1:1 with each other (ignoring transaction fees).


To the best of my knowledge no crypto to crypto peg has ever been broken in a material way.


Until now.


This is the price graph for stETH vs ETH on Lido, one of the largest DeFi platforms with $18bn of TVL (Total Value Locked). This graph is showing that stETH is losing its peg versus ETH, a situation that occurred with USDT that rapidly begot the collapse of the LUNA ecosystem.


Liquidity pools are showing a huge skew away from ETH to stETH – that is staked ETH in normal parlance. On Curve stETH now accounts for three quarters of the ETH/stETH pool.


What does this actually mean in practice?


Well, there is clearly a liquidity constraint to be considered if one is a holder of stETH and wishes to move back into ETH. That constraint would worry me somewhat if I was still a holder of stETH – not everyone can get out, and a large rush for a very small door can cause extreme price fluctuations.


Even more worryingly in my eyes, Lido is putting out platitudes on Twitter that may be true in fact, but do not reflect in any way practical considerations:


“Staked ETH issued by Lido is backed 1:1 with ETH staking deposits. The exchange rate between stETH:ETH does not reflect the underlying backing of your staked ETH, but rather a fluctuating secondary market price.”


All the ingredients are there for a major disruption in a key part of the DeFi world.


If rates keep rising, and risk assets continue to sell-off (two very big “ifs” I grant you), then the potential disruption due to a fatal de-peg between stETH and ETH could lead to much lower confidence in the crypto world for some months to come.

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