The source of the current market volatility and liquidity issues with companies such as Celsius and Three Arrows Capital could be directly linked to staked Ethereum (ETH) on Lido, according to a June 29 report by analysis firm Nansen on the impact of the stETH/ETH depeg on the crypto industry.

Infinite money glitch

When Ethereum is staked into ETH 2.0 via Lido investors, receive an ERC-20 token named stETH. This token is tradeable, and one stETH is redeemable for 1 ETH after Ethereum moves to proof of stake and is merged with the beacon chain.

However, investors can also post stETH as collateral on sites such as Aave to borrow ETH. This borrowed ETH can also be staked on Lido to receive more stETH. This yield loop multiplies the ETH staking rewards but puts the investor at risk should 1 stETH not equal 1 ETH. Lido promoted this strategy via a Twitter post in March.

2) Leveraged ETH staking

stETH on Aave allows you to leverage your ETH staking to maximise staking returns.

1. Supply your stETH as collateral.

2. Borrow ETH against the stETH.

3. Restake borrowed ETH for more stETH.

Repeat this process as much as your risk profile allows.

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— Lido (@LidoFinance) March 1, 2022

How Ethereum brought down Celsius and 3AC

Nansen highlighted that during the UST depeg crisis, bETH depositors (a wrapped bridged version of stETH on Terra) moved their tokens back to the Ethereum mainnet amid fears of the network’s stability. The report stated that 615,980 bETH was bridged back to Ethereum during this time and was unwrapped back to stETH. 

It is this stETH that Nansen claimed was then sold back to Ethereum that started the selling pressure on the stETH/ETh peg, according to data available on its platform. An increase of 567k stETH was added to the stETH/ETH pool of Curve, creating an imbalance and forcing Lido to take measures to attempt to restore the peg.

A large net outflow ensued as investors became worried by the situation and Nansen said that Three Arrows Capital was one of the largest recipients of stETH from Curve. The Three Arrows outflow reportedly totaled 9724 stETH and 486 WETH.

As the price of Ethereum and the broader crypto market, in general, began to fall, Nansen stated

“addresses we flagged as Celsius and Three Arrows Capital were the biggest withdrawers, removing almost $800m worth of liquidity combined (236k stETH and 145k ETH, respectively) on 12 May.”

It continued to comment that “these transactions were most impactful to the initial deviation from the ETH price.” The below transactions are the top wallets that transfer stETH between June 1 and 12. 

From the above wallets, Nansen analyzed the individual transactions to reveal that Amber Group, Celsius, Three Arrows Capital, and several whale wallets all moved serious amounts of stETH during this time. Amber Group and Celsius moved stETH to FTX in a possible OTC trade as stETH liquidity on FTX were too shallow to sell the tokens without incurring colossal slippage. Nansen also revealed that Celsius took out large stablecoin loans from Compound to “possibly meet redemptions.”

After Celsius paused withdrawals, 108.9 ETH and 9,000 WBTC were sent to FTX, originating from one of its leading wallets. This wallet is “still the top 1 lender/borrower for ETH (incl. WETH and stETH) and WBTC collateral across both Aave and Compound with a combined collateral value of almost $1 billion,” according to Nansen.

Three Arrows Capital “withdrew a sizable amount of 29,054 stETH from BlockFi” on June 7 and deposited it between Lido and Aave. Another 3AC wallet borrowed 7,000 ETH from Aave using part of the funds removed from BlockFi as collateral and sent to FTX. Over the following week, several more transactions were made by 3AC with funds deposited between FTX and Deribit. Deribit is one of the largest options and derivatives trading platforms in crypto; depositing funds to this exchange is likely to either pay down margin or open up new derivative contracts.

Nansen revealed that on June 13, 3AC began to sell off its assets by “unwrapping its wstETH for stETH and sold it for wETH via Cow Swap” for a total of 49,021 stETH. 3AC sold tens of thousands of stETH for ETH and stablecoins over the following days, thus, exiting its stETH positions.

Conclusion

The report concluded that Celsius had a liquidity issue, and its need to sell and transfer stETH led to a domino effect. 3AC was a “victim of the contagion” and not the initial cause of the stETH/ETH depeg. Nansen stated that 3AC is “most likely reducing its risks and accepting its losses.” In contrast, Celsius reduced its risk, and “their health ratio is still decent in the context of things, as long as there isn’t a sudden downward swing of >30% in prices of their collateral.”

Leading investment bank Goldman Sachs has downgraded Coinbase’s stock rating to sell from neutral and reduced its price target from $70 to $45 in its latest note, CNBC reported June 27.

The downgrade was caused by the bear market, leading to crypto-assets value plummeting to new lows. Coinbase stock saw a 5.7% drop to $59.40 in premarket trading after the report.

Coinbase’s revenue is dependent on the transaction fees it charges its retail users.

But with the trading activity of this group declining massively due to rising inflation and the crypto market downturn, Goldman Sachs predicts that the exchange revenue could be cut by as much as 61%.

This would be a heavy blow for Coinbase as it reported heavy losses in the second quarter of 2022.

Coinbase may need to sack more workers

The Brian Armstrong-led exchange has been trying to cut costs and recently laid off 18% of its workforce, citing declining revenue and current market conditions.

Meanwhile, its effort to diversify its revenue has not been entirely successful. Its recently launched non-fungible token marketplace has seen little sales since its launch.

According to Goldman Sachs, Coinbase will need to reduce its expenditure to stem the resulting cash burn. It added that the company would have to decide between diluting its shareholders or reducing employee compensation to stay afloat.

Other crypto stocks are at risk too

Coinbase stock is not the only crypto-related stock currently facing headwinds. According to Bloomberg, most publicly traded crypto-related companies have seen massive declines in their stock value.

Almost all publicly traded crypto-exposed companies, like Microstrategy, Silvergate, Marathon Digital, Coinbase, and Riot Blockchain, have lost over half of their value this year.

But Wall Street analysts remain optimistic about the future of these companies. About 20 analysts still recommend Coinbase stocks as a buy despite its recent poor performance.

According to an analyst at BTIG, Mark Palmer, who has a price target of $290 for Coinbase,

While we are not at all dismissive of the impact of the current crypto market downturn, we also believe any notion that Coinbase would be unable to survive this latest challenge is misguided in light of the facts on the ground.