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Do your own research
Disclaimer: Nothing in these docs is financial advice. But you knew that already.
Anytime you use leverage, there is risk.
The amount of risk can vary from minimal to crazy-degen, depending on what you are borrowing, how much you are borrowing, and what you are buying with the borrowed funds.
Suppose I borrow
1 USDand use to buy
1 USD... which is the same thing as just holding onto it. If the value of USD decreased by 20%, my dollar is worth less. But my debt is denominated in dollars, so it has also decreased by the same amount. The dollar that I have can still be used to pay back 100% of the debt principal.
A similar example, this time in crypto. Suppose I borrow
1 DAIand use it to buy
1 USDC. Both are pegged to
USD, with reserves backing that value. So again, if
USDvalue decreases by 20%, both my
DAIdebt are likely to decrease in value by the same amount. My
1 USDCcan repay my
1 DAIdebt principal.
But what if, for some unforeseen reason, the market decides that
1 DAIis worth something less than
1 USD? Suppose in the previous example, the market price of
0.95 DAI. Now it becomes insufficient to repay my DAI debt.
An extreme example of de-pegging risk was the collapse of the
UST"stable" coin on the Terra blockchain, in May 2022.
USTwas not back by equivalent reserves but instead was back by algorithms and incentive mechanisms to maintain the peg to the
USD. Long story short, UST lost its peg, triggering a "bank run" downward spiral until it became worthless. In-depth analyses and opinions can be found elsewhere, but it highlights the fact that mechanism maintaining a peg matters, whether by reserves, incentives, or other means.
Lido staked Ether (
stETH) is pegged to the price of ETH. For every
1 ETHthat gets staked via Lido,
1 stETHis minted. So on this basis, the peg is maintained by 1:1 reserves. However,
stETHcannot currently be redeemed for
ETH. The reason is that the ETH reserves are locked in the Beacon chain staking contract until the merge (or more accurate, the Ethereum update soon after the merge that will enable withdrawals). As such, the stETH peg is based on the promise that sometime in the future, you will be able to redeem
1 ETH. In the meantime, rather than redeeming, you can sell your
sTETHon the market and exchange it for
ETH. There are multiple
ETH/stETHliquid pools on Curve, Balancer, etc. to facilitate this, and the Lido DAO provides
LDOgovernance tokens as incentives for providing liquidity to
stETHin these pools.
stETHrarely trades for exactly the same price as ETH, usually the
stETHprice is slightly less. Until recently,
stETHtraded for between 0.99 and 1.01 ETH, as show in the following chart.
90 Day stETH price denominated in ETH
What happened in mid-May 2022? As mentioned above, the collapse of
USThappened. And the market crashed. One theory is that if UST can collapse, what about other pegged assets? Speculation aside, the fact is that
stETHlost its peg, at least temporarily, and has been trading in the range of
0.985 ETHin recent days (today being May 22, 2022).
As a result of the de-pegging of stETH in May 2022, Aave governance voted to adjust the rsik parameters for
stETHas collateral. Details and rationale can be found in the proposal, but the changes were:
Due to the increased risk, you can now only borrow 69% of the value of your supplied stETH, whereas before you could borrow up to 73%. Perhaps more notable is the new spread between max LTV and the new liquidation threshold of 81%. If you borrowed 69% today the value of your
stETHwould have to drop significantly before you became at risk of liquidation.
Today (May 22, 2022) the price of
0.976 ETH. Suppose you SuperStaked 10 ETH at 69% target LTV. Here is a table with some scenarios that show the changes in LTV at different prices of
The above table shows that
stETHwould need to fall to 82.5% of the price of
ETHbefore hitting the liquidation threshold. (For clarity, note that the above chart does not consider the stETH APR nor the interest on the debt, both of which depend on how much time has passed before reaching the
stETHprice in each scenario). Note that the lowest point during the aftermath of the
USTcrisis, sTETH briefly traded for
0.95 ETHand has never traded below
0.937 ETH. You can make your own determination about the likelihood of the
stETHprice dropping to
0.825 ETHbut hopefully this chart provides some helpful context.
Another risk consideration relates to the Ethereum "merge", when the Ethereum migrates to Proof-of-Stake (PoS). Some predict this will happen in August 2022 and that a subsequent update to enable withdrawals of staked ETH by the end of 2022. But these dates are not guaranteed.
There are two key implications to consider:
- When withdrawals are enabled, holders of
stETHwill be able to redeem
1 ETHfrom Lido protocol directly, and will not longer need to rely on liquidity pools and market prices. In theory, de-pegging risk is then reduced.
- After the merge, ETH stakers -- including holders of
stETH-- will begin receiving a share of Ethereum transactions fees and MEV, in additional to ETH issuance. While this may not directly affect the risk, it will increase the rewards. How much? Speculation is left to the reader.😉