Can liquid staking tokens depeg due to market volatility?

The $45 billion liquid staking sector is raising concerns among investors over the long-term price stability of cryptocurrencies tied to these protocols.

Liquid staking creates more capital efficiency for investors by offering an equivalent of the initial staked token that can be deployed in other decentralized finance (DeFi) applications.

However, liquid staking tokens (LSTs) could temporarily lose their price peg to Ether, according to Carlos Mercado, a data scientist at Flipside Crypto research firm.

Mercado told Cointelegraph:

“A broader risk is what happens when a significant percent of Ethereum is staked- the liquid staked tokens don’t have instant redemption, so in high volatility time periods they can “depeg” where the open market price differs from the (often verifiable) ETH backing.”

Maintaining price stability for Ether-based LSTs is crucial, as their cumulative market capitalization stands at $36.5 billion, according to CoinGecko.

Arbitrage bots could quickly tackle LST depegging

Although temporary depegging can occur during volatile periods, crypto arbitrage bots may quickly resolve such discrepancies. Arbitrage bots analyze price differences between crypto assets and execute trades to exploit those gaps.

These same arbitrage bots could automatically fix an LST depegging event, according to Alon Askal, the vice president of marketing at SVV Network. Askal told Cointelegraph:

“If there was an adversarial market movement in either direction, arbitrage bots and user redeems would quickly stabilize and bring the peg to an equilibrium, as the Shanghai upgrade enabled protocols such as Lido to exit from the beacon chain and get back the ETH.”

On April 24, the Renzo ETH (ezETH) token lost its 1:1 peg to the Ether price, temporarily falling as low as $700 on decentralized exchange (DEX) Uniswap, while Ether was trading above $3,100.

A wider sell-off caused the incident thanks to the culmination of Renzo’s airdrop campaign, which caused widespread liquidations across leverage protocols, according to Tommy, a pseudonymous investor at Crypto.com capital.

The investor explained in an April 24 X post:

“This led to liquidations on leverage protocols such as @GearboxProtocol and @MorphoLabs. Loopers (users who repeatedly use LRT as collateral to borrow ETH to create leverage) suffered loss as a result.”

Liquid staking is growing cross-chain

Liquid staking has seen significant growth across other top blockchain protocols, not just Ethereum.

Over on Solana, liquid staking could see an over fivefold increase, according to Bytbit researchers, who told Cointelegraph:

“In our view, Solana has a huge potential for liquid staking due to its active staking community. Based on Ethereum’s LST market statistics, Solana’s LST market could potentially grow to $18 billion.”

Thanks to the increased capital efficiency created by the protocols, liquid staking grew into the largest protocol category in DeFi, worth a combined $45 billion across 190 protocols, DefiLlama data shows.

Source: https://cointelegraph.com/news/liquid-staking-tokens-depeg-market-volatility