Can liquid staking tokens depeg
Liquid staking has become a huge market sector worth in excess of $45 billion, but investors are now asking serious questions about the long-term price sustainability of tokens connected to these protocols. In recent days, it has become clear that the market price of liquid staking tokens (LSTs) can depeg from that of the underlying native asset, such as Ether, during conditions of significant onscreen volatility. These mechanisms, however, have not stopped some LSTs from briefly deviating by as much as 77% in price away from Ether — leading to discussions on the security and stability of these assets.
What is Liquid Staking?
Liquid staking is a mechanism in cryptocurrency that permits users to stake their cryptocurrency assets but maintains them liquid. With normal staking this means that when users stake their tokens on a proof-of-stake (PoS) blockchain, their tokens get locked and cannot be used or traded until these are unstaked. In contrast, liquid staking changes this because the user can stake their token and receive a liquid token in exchange that represents their staked assets.
In simple terms, liquid staking gives users the ability to:
- Stake their tokens to earn rewards.
- Use or trade a liquid version (derivative) of their staked assets while still earning staking rewards.
Key Elements:
- Staking Rewards: Users still earn rewards from staking, just like traditional staking.
- Liquid Token: In exchange for staking, users receive a liquid token, which can be traded or used in decentralized finance (DeFi) applications while their original assets remain staked.
- Liquidity: Even though their original tokens are staked, the user has access to liquidity through the liquid token, allowing for more flexibility in the market.
For instance, when you stake 1 ETH in a liquid staking protocol, you might receive something like an stETH token, which can be traded or utilized in other DeFi applications while still earning staking rewards on your original ETH.
Liquid stacking is a power approach — you get your liquid and flexible and will be able to participate in stake without losing any different funding or buying and selling activity.
What are liquid staking tokens?
Liquid staking tokens (LSTs) are derivatives tokens that stand for staked assets in a liquid staking protocol. In liquid staking, when users stake their original tokens (ETH or SOL), the underlying proof of stake (PoS) blockchain is secured and rewarded for providing rewards to where they are staking at any point in time.
In exchange, it issues them tokens that represent a claim on the staked coins, freely tradable or even usable in DeFi Apps while relinquishing access to those coins (hence they are’staked’).
Popular Liquid Staking Tokens:
- stETH: From Lido, it represents staked Ethereum in Ethereum 2.0.
- rETH: From Rocket Pool, it represents staked Ethereum with Rocket Pool.
- mSOL: From Marinade Finance, it represents staked Solana.
- bLUNA: From Anchor Protocol, representing staked LUNA on the Terra blockchain.
- BNBx: From Ankr, representing staked Binance Coin (BNB) on Binance Smart Chain.
- sAVAX: From Benqi, representing staked AVAX on the Avalanche network.
- cMATIC: From Stader, representing staked MATIC on the Polygon network.
- sDOT: From Parallel Finance, representing staked DOT on the Polkadot blockchain.
- stATOM: From Persistence, representing staked ATOM on the Cosmos network.
- stKSM: From Karura, representing staked KSM on the Kusama network.
How Liquid Staking Works?
Liquid staking is a class of capital efficiency in which investors can benefit from participating in staking rewards while also holding the equivalent liquid staking token to use in other DeFi protocols. This allows investors to get the most out of their assets, using various strategies on various platforms.
Yet for all this capital efficiency, the peg of LSTs to their underlying can break — especially in moments of market stress. A major risk source, however, emerges when an even larger share of Ether is staked — as noted by Carlos Mercado, a data scientist at Flipside Crypto. Liquid staking tokens are not immediately redeemable, Mercado said. Even though there is ETH behind them, during times of high volatility the market price can “depeg” for these tokens moving against that support.
How Depegging Happens: One Such Case Study
Renzo ETH (ezETH), a liquid staking token, is one of the most eye-catching displays of depegging we detected on April 24 when its peg to Ether shrunk from a 1:1 ratio. It fell to as low as $700 on the decentralized exchange Uniswap, while Ether was above $3,100. A combination of them led to this dramatic price drop, including a massive sell-off initiated by Renzo´s airdrop campaign. This sell-off resulted in liquidations due to its effect on leverage protocols, which further exacerbated the depeg.
The article has been written by Tommy, a pseudonymous investor at Crypto. Lumerin CEO and cofounder Stephen Arsenault, who goes by @stephenarsenault on X (formerly Twitter), described the aftermath as “merciless,” detailing how leverage protocols like the Gearbox Protocol and MorphoLabs were especially affected. The price drop caused severe losses for traders who took leveraged positions by looping with LSTs—using LSTs as collateral to borrow ETH.
Can Arbitrage Bots Save the Day?
While there may be instances when LSTs experience a depeg, especially in times of market upheaval, crypto arbitrage bots can help to play one of the pillars to stabilize the price. These bots measure when asset prices diverge between different exchanges and then trade accordingly, profiting off of price gaps. Alon Askal, SVV Network’s Vice President of Marketing, says that arbitrage bots can play a key role in fixing LST depegging.
Askl said arbitrage bots together with user redemptions would return the peg of an LST to its equilibrium quickly. All thanks to Ethereum’s Shanghai upgrade, which enabled platforms like Lido to exit from the beacon chain and redeem ETH, keeping its price stable despite extreme market conditions.
Cross-Chain Growth of Liquid Staking
Ethereum still reigns supreme when it comes to liquid staking; however, the trend is quickly spreading across different blockchain networks, such as Solana. Bybit research sees Solana’s liquid staking market potentially growing up to five times larger and reaching as high as $18 billion. Solana has an active staking community, and with the capital efficiency liquid staking protocols, this forecast makes sense.
As per a DefiLlama, liquid staking has overtaken the largest sector in DeFi, standing at a sum of $45 billion across 190 protocols. Now, this cross-chain expansion just sends the LST price stability fears in overdrive, with each protocol subject to its own risks relative to whatever is native to the blockchain that you are staked on.
Epilogue: Stability or Volatility?
Liquid staking is an interesting mix of both liquidity and yield but has its own risks too. And while this market maker strategy does beta-proof LSTs to a degree, the risk of LSTs depegging from their underlying asset in times of extremes is a valid and pressing concern (thank you, UST). But triggers such as arbitrage bots and protocol upgrades are in place to counterbalance these risks, and reassure investors slightly.
Liquid staking is here to stay — Onboarding fundamentals within an expanding multi-chain market, but stability in price will be key amongst all levels of liquid-staking optimism that unfolds between now and the end-game. This crypto market could see growth and volatility like this with a market cap now over $45 billion.
