How Ethereum Staking is Creating a $10 Billion Ponzi Scheme

The Ethereum merge happened. Users got slightly cheaper gas and a small boost in the number of blocks created per day, along with the looming problem of censorship and the existence of decentralization in general. What's next?

In fact, there is a much more dangerous problem with the new Ethereum staking. In this article, we will talk about one of the largest Ponzi schemes in history. These are big, world-famous VCs-backed validators that offer win-win conditions for anyone who wants to profitably stake their ETH. But in reality, investors are in a financial pyramid of more than $10 billion which will collapse at any moment.

Proof of Stake restrictions lead to the Disaster

The Proof-of-Stake algorithm assumes that the “weight” of the validator’s vote depends on the number of coins staked. The amount of locked funds determines the reward of the node. To become an Ethereum validator, you need to deposit 32 ETH on a deposit contract. What many people don't know is that once you stake your ETH, you won't be able to withdraw your tokens until the Shanghai Update, which is currently undetermined. Thus, users simply do not have the ability to withdraw the tokens they have staked. This situation allowed large validators to organize a Ponzi scheme that no one is talking about yet.

What is happening?

Considering that Ethereum has a staking requirement of 32 ETH for validators that produce blocks, a large number of people simply cannot afford to allocate such an amount for staking. Therefore, for those who do not have such an amount of ETH, large protocols - validator aggregators, offer to delegate almost any amount and receive a percentage yield on it. We are talking about sites like Lido, Rocket Pool, Stake Wise, StaFi, Ankr Staking, etc. In addition, when delegating Ethereum to these protocols, they exchange it for various tokens, such as sETH, stETH, rETH, rETH2, etc. For example, the Lido protocol gives away its stETH tokens in exchange for your ETH, which you cannot exchange back for ETH on Lido itself or other similar sites. Basically, by making an exchange and staking your ETH on the aforementioned protocols, you lose your ETH forever, and in return you get a token that you cannot exchange where you got it. Why?

The staked ETH issued by Lido is backed by ETH collateral deposits at a ratio of 1:1. But the problem is that the token is traded on various decentralized platforms such as Curve, where stETH accounts for 68% of the 397,000 stETH liquidity reserve.

Thus, not everyone will be able to exchange their stETH back for ETH at all. At the moment, in the example of theCurve Finance pool, we can see that for 397,256 stETH there is only 184,185 ETH. It means that if someone wants to exchange stETH for the equivalent of 100,000 ETH, the remaining amount of ETH in the pool will be 869,140 stETH, for only 84,000 ETH. It has a huge price impact.

Even the protocol itself says that when exchanging a large amount of stETH, the impact on the cost of stETH will be simply immense. But in fact, this is a calculation of the exchange of one transaction. In fact, the situation will be much worse as the real price change is calculated using the invariant above.

stETH alone has over 120,000 holders, and only 40% will be able to get  all their money back, and these are the most optimistic forecasts. Not to mention that the chain reaction will not be long in coming.

According to Dune, the stETH/ETH imbalance on Curve has already reached an alarming 70%/30%.

For example, In June 2022, stETH dropped by -7.6% from its usual price of 0.99 ETH to 0.92 ETH and triggered a panic sale. Such a fall is connected with the uncoupling of the sensational fall of TERRA USD.

Later, the rate stabilized, but things could have turned out differently and started a chain reaction like Terra did.

Here is what Lido itself writes about the risks of using stETH:

What can happen?

According to Nansen, more than 70% of stETH was bought above the $14,25 ETH price, which means that only 18% of stETH participants are in a profitable range, now this number is slightly higher, but the situation is not improving. This means that most of the illiquid players may exit their market positions and start a selling wave, as happened with the Terra protocol. Such a situation will definitely arise with the release of the Shanghai update, but it can happen much earlier, in the current macroeconomic situation, any event can trigger the decoupling of stETH, sETH, rETH rates from native ETH, which will lead to a panic sale of assets and the collapse of the $10 billion Ponzi and the loss of funds about a hundred thousand investors.

Conclusion

stETH currently offers a yield of 5.5% per year, with all the huge risks that are described above. At the same time, Lending protocols, for example, the Iron Bank protocol offers to place your native ETH at 4.03% per year with virtually no risks and no problems.

You can withdraw and sell tokens at any time, you just need to monitor the utilization rate. Whether a 1.5% return on such risks is worth it is up to investors to decide, but most people do not understand that this 1.5% is behind another Ponzi scheme that can collapse at any moment.