The crypto market has been crazy for the past few weeks, dropping by more than 50% spreading fear in the market and signaling the possible start of the bear market. This sudden market crash has also introduced many market inefficiencies. For some DeFi degens they have found ways to tap into these unique opportunities. This post will be focused on one of these inefficiencies and how users can use it to earn a +10% APR on USDC in the current bear market.
Let me start by sharing that almost all my ETH holdings are in the form of Lido Staked ETH (stETH). Using the following strategy you can potentially take advantage of the current market inefficiencies and earn while the market recovers the price of stETH. I myself am actively using this strategy! In this post I’ll cover the idea behind this strategy, how to set this up and We will review the risk profile of this strategy.
What is stETH?
stETH is the tokenized ETH staked into the ETH Beacon Chain sometimes called ETH 2.0. stETH earns pure ETH POS staking rewards (the best kind of reward in the entire crypto ecosystem). 1 stETH is fully backed by 1 ETH on the beacon chain this means 1 stETH = 1 ETH. Anyone can mint 1 stETH with 1 ETH through Lido.
stETH is sometimes described as being ‘pegged’ to ETH but this is a bit of a misnomer. stETH is backed by 1 ETH similar to how 1 USDC is backed by 1 fiat dollar in a bank account; compare this to DAI or UST which are not backed by fiat dollars but instead their price is pegged to the dollar. While stETH is not actually ‘pegged’ to ETH we may refer to peg/depeg in the context of the ETH market price to stETH.
Why is stETH trading at a discount?
stETH once minted cannot be redeemed until withdrawals on ETH 2.0 goes live. While no one knows the exact date, we can estimate it is at least 7 months away. In the bull market, stETH (and all other cryptos) had high demand. High demand resulted in an increase in the supply of stETH in the market allowing users to earn rewards on their ETH but due to the recent market crash, the demand has substantially decreased which resulted in a decrease in the exchange price of stETH w.r.t ETH.
How to benefit from this inefficiency?
If you believe that the stETH will eventually be redeemable for its backed ETH on the Beacon Chain then you would also assume that each stETH will be equal to 1 ETH sometime in the future. It can even happen in the next 2 months if the price of stETH in the market recovers or when the ETH 2.0 redemptions starts which doesn’t have a fixed date yet.
At the time of writing this: stETH is at a +6% discount w.r.t ETH.
Starting assets: $100k USDC.
Let’s assume 1ETH = 1000 USDC for simplification.
End position: (I’ll be taking Aave protocol for examples but can also be done using Euler)
- 112,000 USDC collateral (Tap into 12k USDC returns now)
- 200 ETH debt (or 212 ETH debt)
- 200 stETH collateral (or 212 stETH collateral)
The target is to have ETH debt = stETH collateral to be able to close the full position when stETH gets stable and realize the entire profit.
3 Steps process: (I’ll be using Aave with Instadapp to reduce the steps by utilizing the strategies)
- Deposit 100,000 USDC into Aave
- Use leverage strategy for ETH to stETH.
- Borrow 200 ETH.
- Swap ETH for 212 stETH.
- Deposit 212 stETH in Aave.
- Use leverage strategy for ETH to USDC.
- Borrow 12 ETH.
- Swap ETH for 12000 USDC.
- Deposit 12000 USDC in Aave.
Position riskiness w.r.t stETH depeg (keeping market prices same for simplicity in the calculation):
- ETH debt = $212k.
- Min collateral requirement = $212k/0.83 = $255k. (USDC liquidation is at 0.88, stETH is at 0.81. Taking an average limit of 0.83 effective collateral factor)
- USDC collateral = $112k.
- stETH collateral needed = $255k - $112k = $143k.
- stETH price w.r.t ETH when stETH collateral value is $143k = 143000 / (212 * 1000) = 0.674528302 ETH. Meaning ~32.5% depeg is needed to liquidate this position.
But the actual depeg risk will be much higher than 32.5% as the depeg happens when the market crashes. When the market crashes ETH & stETH price goes down but USDC stays the same meaning the effective power of stable USDC collateral increases allowing it to handle more than 32.5% depeg. Vice versa happens when the market surges the effective power of stable USDC collateral decreases but at the same time, the stETH peg also gets better allowing users to close the position early.
Similarly, if a user wants to have less risk exposure then the user can decide to go with less leverage. Ex:- going leverage by 1x (100 ETH) will decrease the risk to ~80% depeg. That means, the user’s position will liquidate when stETH = 0.2 ETH (if all the other prices in the market stays the same).
- Smart contract bug: This strategy involves Lido’s stETH, Aave protocol & Instadapp’s smart accounts.
- ETH borrow rates getting higher than stETH reward rate.
- Subject to depeg risk as per your ratio.
Layman’s Summary of this Strategy
Essentially you are able to capitalize on the current market inefficiency by first building a capital allotment, in this case using USDC. Utilizing that capital to borrow in ETH and buy stETH at a discounted rate which you can immediately cash out. You also continue to decrease the size of your debt with ongoing staking rewards. To fully realize the profits made by the difference in stETH/ETH price you have to close the position when the stETH price is restored to at least 1 ETH.
Written by Samyak