Lido — A harsh warning of our crypto fragility

Commentary by Leticia Martignon — a crypto learner

 

Most crypto enthusiasts enter the space to find an alternative to traditional investment tools, especially in current times of high inflation and negative saving rates, where the value of fiat currencies shrinks by the day. But what makes crypto so exciting is also its Achilles heel.

Lack of regulation and historical data, as well as a community of often highly intelligent and highly ambitious people, make this experimentation better suspense than Netflix. The recent freezing of withdrawals by Celsius, a crypto lender, have shown that the next big systemic risk is just around the corner.

Risk and reward

The DeFi space is proving an ever-growing list of new mechanisms and opportunities that simply haven’t been tested yet. DYOR has thus turned into a complex activity that requires deep understanding of the underlying mechanisms and risks involved with each project’s selling proposition.

Staking is one mechanism that DeFi has created for those that want to protect their wealth against inflation and make an interesting return on blocked capital. It looks attractive and some projects and lenders have promised returns of up to 20%, which is huge compared to any savings account’s interest rate. Who wouldn’t want to stake? Seems like a no brainer. But sounds like Madoff, too, right?

No safety net

While traditional banks in most developed countries have government insurance in case of bankruptcy for a portion of the assets they hold on behalf of their clients, most crypto projects don’t have any kind of insurance whatsoever. Add to that the risk of projects getting hacked and a still immature market where any player can grow exponentially within weeks and shift the landscape, and you have an explosive combo on your hands.

Recently, the Celsius Network has been all over the news as it experienced pressure not only from the markets but also clients and chose to suspend all withdrawals from its platform. While looking into the Celsius case, I came across Lido, a liquid staking protocol run as a DAO, which currently holds the highest single agent percentage of staked ETH with more than 30% on the Beacon chain.

A virtuous and vicious cycle

The staked ETH (stETH) from the Lido platform is a token you receive and can reinvest while your ETH is fully blocked until The Merge, when the Beacon Chain will eventually replace the Ethereum proof-of-work algorithm. This liquidity (hence the name liquid staking) increases the number of times you can make your money produce return. You can increase your potential upside, because you receive yield not only through staking but also while you reinvest for more yield or returns in the markets. Celsius was using a large portion of the funds of its lending clients to do just that. The idea was to stake through Lido, get stETH, reinvest through DeFi, pay the promised return to clients and pocket the rest.

It’s a legitimate strategy, one which banks have used for decades. But in crypto (traditional finance as well, by the way) it can easily come apart when one single element in the complex machine suddenly moves. And it did.

Slipping off

Due to market conditions following the TERRA-LUNA meltdown, stETH was no longer close enough to the value of ETH so that the sweet formula by Celsius could continue to work. While the slipping ratio reminds us painfully of the UST de-pegging, Jacob Blish of Lido clarified to Fortune Magazine that this is not an algorithmic stablecoin scenario but a token fully collateralised by ETH through the smart contract.

So we’re fine for now. (Unless we wanted to pull out our funds from Celsius, of course.) And Lido is far from the only potential issue on Celsius’ books. But when digging into this very new topic for me, I read more than one reaction from the leaders of this type of project that went along the lines of ‘We are not the police’ and ‘Crypto is your own adventure.’ While that is true, and the reason why I do not buy 99.9% of tokens, I cannot help but wonder how these projects would do if everyone was like me. Or if everyone was really good at DYOR, for that matter.

Understanding these mechanisms and interdependencies is highly complex. Which is why we need research, strategies, education and frameworks to make this space ready for the adopters that are still about to arrive.

Disclaimer: This is not financial advice, but the opinion of our commentator. Crypto is a risky and volatile asset. Kryptview cannot be held responsible for any investment decisions you make. Do your own research.

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