Memories are proving to be short once again in the cryptocurrency market, where speculators are piling into tokens that are helping to magnify bets on the success of the next upgrade of the Ethereum network.
(Bloomberg) — Memories are proving to be short once again in the cryptocurrency market, where speculators are piling into tokens that are helping to magnify bets on the success of the next upgrade of the Ethereum network.
Coin prices have jumped across the board in recent weeks, just months after an industrywide meltdown that prompted skeptics to dust off predictions for the demise of the embryonic asset class. Among the biggest gainers — with some coins posting triple-digit increases – are tokens tied to so-called liquid staking apps, which provide Ether holders a way of earning yield without having to sell their tokens.
The rally is reminiscent of the euphoria that gripped investors ahead of the long-anticipated software revision known as the Merge in September. That update shifted the blockchain to a system called proof of stake, where Ether is used to help order transactions on the network in exchange for rewards based on the amount of new tokens minted and fees collected. The next phase, known as Shanghai and expected in March, will allow Ether holders to withdraw their staked coins. That has the tokens of staking apps including Lido and Rocket Pool taking off.
“Those tokens have been going absolutely bonkers, because people are anticipating a massive rise in adoption,” said Henry Elder, the head of decentralized finance at Wave Financial. “That has been one of the most popular trades during this bear cycle and has helped keep that piece of the market afloat.”
What investors appear to be forgetting is that some of the same protocols played a role in last year’s market collapse. Now bankrupt hedge fund Three Arrows Capital was investing on the Lido Finance platform to generate yield through staking. Lido depositors get another tradable token called stETH, or staked Ether. The derivative traded at par with Ether until the Luna stablecoin ecosystem crashed. The price of stETH soon slid to as low as a 7% discount as traders rushed for the exit amid a dearth of liquidity, before recovering.
That was also before the failure of crypto lenders including Genesis, BlockFi and Celsius, which have been criticized for loose lending standards that helped to fuel the leverage that pushed token prices to record highs late 2021.
The token used to govern the Lido app, called LDO, is up more than 200% since Nov. 9, when crypto exchange FTX’s collapse sent the entire market into the latest tailspin, according to tracker CoinMarketCap. Rocket Pool’s RPL has almost tripled since then, while StakeWise’s SWISE has appreciated 2.5 times, according to CoinMarketCap.
With about $8.15 billion worth of Ether locked in the protocol, Lido has surpassed MakerDAO to become the largest decentralized-finance application, data from Defi Llama show.
Once withdrawals are enabled, some 20% of Ether in circulation will be staked by year-end, up from about 13% today, said Kunal Goel, an analyst at researcher Messari.
Something called “the great reshuffle” is expected as well: Some existing owners of staked Ether may move their holdings from centralized exchanges like Coinbase Global Inc. and onto more decentralized apps with governance tokens, said Marc Arjoon, a London-based research associate at CoinShares.
“When withdrawals are enabled, we are going to see a lot of withdrawals, that might cause a little bit of panic,” Arjoon said. “A lot of people would want to withdraw from these centralized exchanges not only for the whole ethos of decentralization but as rational actors that want to maximize profits, they would want to stake with an entity that doesn’t take as big of a cut.”
To try and capture this expected surge in demand, Rocket Pool is seeking to make itself more attractive by reducing the amount of Ether a person needs to stake to run a node — a computer that helps operate the Ethereum network — for the app. New entrants are jumping in as well. Last fall, stablecoin issuer Frax created liquid-staking derivative Frax Ether that yields more than 10%. Stader is planning to launch an Ether staking derivative.
Even after Shanghai, liquid-staking derivative tokens will come with risks. Withdrawing staked Ether from the Ethereum network could still take days or even months. While liquidity of the tokens will likely be better, it’ll still be possible to get stuck in them.
“The other big risk would be security risk,” said Conor Ryder, research analyst at Kaiko. “Security risks are slightly different for someone like Lido and stETH, in that most of the risk probably lies in a smart contract bug or if the protocol was hacked.”
And of course, the proverbial hottest trade never stays so forever. There is the risk that speculators who ran up the prices of the governance tokens for liquid-staking apps will sell just before or after Shanghai is implemented.
“Everybody buys the rumor and sells the news,” Elder said. “After Shanghai goes live, we’ll probably see a market correction. But then it’s going to find a base.”
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