Staked Ether (stETH), a token of the Lido protocol designed to trade at a price close to that of Ether (ETH), has changed hands at a sustained discount since the collapse of the Terra network, possibly a sign that liquidity in crypto markets has dried up.
Data shows that stacked Ether and Ether traded at parity until May 7, when Terra's stablecoin, UST, began to wobble from its $1 peg. Since then, stETH has been unable to recover to its full ETH price. On May 12, when UST fell to 7 cents, the stETH-ETH exchange ratio dropped to 0.955, and since then, stacked Ether has traded at a 2-3% discount.
The discount is the result of an "illiquidity rush" triggered by the UST implosion in an already tightening macroeconomic environment, as terra enthusiasts realized they were overvalued and began selling other coins out of panic, Fundstrat analyst Walter Teng told CoinDesk in a Telegram chat.
"At this point, there is no new money flowing into cryptocurrency," Teng said.
After UST's crash, "everyone is testing, everyone wants to catch another emperor without clothes. In the case of StETH, shorters are betting against the success of the ETH merger, a liquidity event for StETH," he said.
Ethereum's switch to proof-of-stake, or "merge," is scheduled for August after many delays. If the switch is delayed again or fails, stETH holders would be left sitting on their investments, so it makes sense for them to seek compensation for that risk now.
A good indication that liquidity is running low in the crypto market is the overall market capitalization of stablecoins - the main source of liquidity for crypto traders that is considered a safe haven from volatility - which fell when people pulled their money out of cryptocurrencies in a panic in May.
Add to that the fact that the U.S. Federal Reserve is raising interest rates and reducing its balance sheet, tightening conditions in money markets and lending as investors sell risky assets like stocks and cryptocurrencies in search of safety.
Ethereum is switching to a consensus mechanism where stakers validate transactions and propose new blocks, rather than a proof-of-work process where so-called miners power machines.
Lido is a decentralized financial application that allows ETH holders to stake tokens to validate transactions and earn a return. Investors receive the Ether token wagered at a one-to-one ratio and can use it as loan collateral or in supported trading pools.
The limitation is that holders cannot buy back and sell their staked Ether until the merger.
As a result, lower staked Ether prices are the result of an "illiquidity discount" during a time of turmoil when traders value investments that can be easily sold.
Dustin Teander, an analyst at blockchain data platform Messari, said that "there's not a lot of natural incentive to return to price parity right now." He added that Lido has voted to issue new rewards to the curve pool to support price parity, and that seems to be working as the discount is heading toward 2%.
Lido is critical to Ether as it manages 91% of all liquid Ether in its pools and manages a total of about $7.8 billion in Ether, according to data platform DefiLlama.
Danny Ryan, a researcher at the Ethereum Foundation, wrote Wednesday that liquid wagering platforms like Lido pose unique risks to Ethereum if they grow too large and could lead to "cartelization" of the Ether wagering market.
A Goldman Sachs report in early May said the discount in Ether deployment following Terra's collapse could indicate that interconnectedness in decentralized finance is increasing systemic risk.
Ether (ETH) was trading at $1,815 at press time, while Lido Staked Ether (stETH) was trading at $1,785, according to crypto price tracker CoinGecko. The stETH-ETH conversion rate was 0.977.