Rumors on the death of stETH
Plus you can now be served court papers by NFT
In this issue:
Repent! The Recession is nigh!
Rumors on the death of stETH
Interwebs are numbered in Fibonacci order
You can now be served court papers by NFT
Repent! The Recession is nigh!
I don’t talk a ton about macroeconomics in Something Interesting in part because there are other, better sources for that kind of news and in part because I think trying to predict macro trends is just white collar astrology. But at a certain point not talking about the broader economic context is ignoring the elephant in the room.
The price correlation between Bitcoin and the S&P 500 is the highest it has ever been. That’s a bummer because (a) Bitcoin is supposed to diversify your portfolio and (b) the S&P 500 is performing terribly at the moment. The economy right now is like Wile E. Coyote after running off the cliff’s edge but before looking down. The U.S. Consumer Price Index (what people usually mean when they say inflation) is the highest it has been in 40 years. The last time inflation was this high the Fed Funds rate was 13%, almost 16x higher than it is today. Pain.
The Fed (and central banks generally) are trying to balance employment against inflation. When unemployment is high and inflation is low they try to juice the economy by lowering rates which ultimately makes it easier to get loans. When inflation is high and unemployment is low they try to cool the economy down by raising rates which makes loans more expensive.
The problem is the Fed is between a rock and a hard place: inflation is high, but the economy itself is quite fragile. The mortgage market is so spooked by the possibility of Fed action that on Friday the mortgage backed securities (MBS) market briefly went no-bid, i.e. no buyers at any price. Everyone is so worried the Fed will be forced to raise rates that no one wants to make loans to people buying houses. Pain.
You might think that low rates and rising prices mean the dollar is weakening but actually USD is the strongest it has been in a decade. Businesses and investors are anticipating a recession so they are selling assets and amassing cash. What’s actually happening is a supply shock, especially in energy prices. Normally a stronger dollar means cheaper oil, but that isn’t happening right now. Basically everything uses energy so more expensive oil means more expensive everything. Pain.
So the Fed can raise rates to strengthen the dollar, but the dollar is already strong. They want to avoid a recession, but a recession is probably already happening.
Pain.
Rumors on the death of stETH
We first talked about stETH at the start of June, when I wrote about the centralization threat that liquid staking protocols pose to proof-of-stake consensus networks. stETH is the native token of the Lido protocol. Users deposit ETH with Lido and get back stETH as a kind of receipt. Lido uses those deposits to do proof-of-stake validation on the Ethereum beacon chain. Ethereum pays Lido a yield for their staking services and stETH balances grow automatically to reflect that growth. That means at any given time there is 1 stETH in circulation for every 1 ETH deposited with Lido.
Because there is 1 ETH for every 1 stETH in circulation many people have been treating stETH as though it is interchangeable with ETH, but that has never been true. Staked ETH is not equivalent with unstaked ETH because (a) it pays a yield to stake and (b) you have to unstake it if you want to withdraw and sell. That’s especially relevant right now because devs haven’t actually implemented unstaking yet and withdrawing won’t be possible until they do. Right now staking ETH is like checking into the Hotel California.
So stETH is less like a stablecoin pegged to ETH and more like an ETH denominated bond with an unknown maturity date. The price of stETH is not a function of the price of ETH but instead is a function of how the market values the yield being paid to validators relative to the yield being paid for liquid ETH, discounted by the risk of Lido failing or delays to the Merge. Usually that means stETH trades at a slight discount to the price of spot ETH. Recently that discount has gotten steeper:
The market is still recovering from the Terra/Luna collapse so anything that looks like a depegging stablecoin causes a lot of anxiety, but the comparison isn’t super informative. TerraUSD (UST) collapsed under a crisis of confidence because confidence was the only thing backing it — stETH on the other hand is fully backed. The issue with UST was solvency. The issue with stETH is liquidity.
The problem isn’t really with stETH, which is working as intended. The problem is people started treating stETH like a highly liquid token with a price that closely tracked ETH and neither of those things turned out to be true. There are two groups in particular that are probably looking at the graph above and panicking.
First are leverage traders who used ETH to buy stETH and then used the stETH to borrow more ETH (and potentially did that trade recursively again). If the price of ETH/stETH stayed together that acts kind of like a free multiplier on your ETH investment — but when the price of stETH drops those traders need to produce collateral to keep their loans from being liquidated. It’s impossible to know how many people took that kind of position but it was a popular one. For example Instadapp is an app that automates the recursive stETH leverage trade — their ~$240M vault will be liquidated if the price of stETH falls to 0.86 ETH.
The other group sweating bullets are pseudobanks like Celsius1 that borrowed ETH from users and deposited it into Lido for the staking yield. If users keep withdrawing their ETH before stETH withdrawal is available (which seems to be happening to Celsius) then Celsius will be forced to sell stETH at a significant loss in order to honor customer redemptions. At least ~73% of Celsius’s ETH is either locked in stETH or staked directly and they also lost a significant amount in several recent hacks and in the collapse of Terra/Luna. There are reports that users attempting to withdraw have started finding their accounts locked in "HODL Mode."
If the stETH price triggers a liquidation cascade (which seems likely at this point) it wouldn’t affect the USD price of ETH directly and it shouldn’t really affect anyone’s assessment of ETH as a platform or even of stETH itself. But if a bunch of players like Celsius and Instadapp are thrown into insolvency they will turn into forced sellers of the rest of their assets — and it seems likely those fire sales will affect ETH.
Pain.2
Other things happening right now:
Jack Dorsey’s new Bitcoin venture TBD announced "Web5: The Decentralized Web Platform,” a Google Slide deck outlining a broad set of proposals for how to use decentralized identifiers (DIDs), decentralized web nodes (DWN) and verifiable credentials (VCs) to rearchitect the web in a way that left ordinary users with more control over their data and identity. If you’re wondering why we went straight from Web3 to Web5 it’s because interwebs are numbered in Fibonnacci: first there was the web, then the web again, then Web 2.0, web3 and now Web5. Up next will be Web8. It’s all perfectly cromulent.
Do Kwon has been accused of cashing out ~$2.7B or so UST into other stablecoins in the months leading up to the Terra/Luna crash. Kwon denied the rumors as "categorically false" but he didn’t bother to actually explain any of the suspicious transactions. Even if the money wasn’t taken by Kwon it still raises awkward questions. If everyone genuinely thought UST was stable, why was someone racing to withdraw ~$80M/month?
A group of anonymous Coinbase employees started a petition to remove some senior executives from the company. That’s a bit silly and petty but it is the sort of thing that happens at a company when the stock is down ~80% from its IPO price. CEO Brian Armstrong defended Coinbase’s strong, pro-feedback culture by calling the petition "really dumb" and promising to fire anyone involved.
Earlier this month the hacker behind the $8M hack of cryptoexchange LCX was served court papers via an NFT. Obviously that sounds a bit daft but it is actually a fairly practical approach to providing legal notice to anonymous hackers whose identity isn’t known but whose wallet addresses are. Overall I actually think that’s kind of a neat approach.
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