Crypto Carnage Deepens as Ethereum Investors Run for Cover Amid stETH De-pegging and the Resulting DeFi Space Turmoil

Jim Cramer, the CNBC anchor whose recommendations have become famous recently for consistently generating alpha provided that investors take a diametrically opposite trade to the one recommended by Cramer himself, had heralded red days ahead for the broader crypto sphere by issuing a “buy” recommendation for Ethereum and Bitcoin on the 08th of June. Well, just five days later, the crypto world has been engulfed in the proverbial fire and brimstone.

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The ongoing carnage in Ethereum and the rest of the crypto sphere has two main stimulants behind it: the macroeconomic headwinds and the DeFi space turmoil spurred by stETH’s de-pegging. Let’s go over these factors in detail.

The Federal Reserve’s Firming Hawkish Stance Spells Further Weakness for the Crypto Sphere

On the 10th of June, the much-anticipated US CPI report for the month of May was published, ushering in turmoil in the risk asset universe. To wit, the headline inflation for May rose 8.6 percent on a year-on-year basis to the highest level since 1980. Core inflation – a metric that excludes the more volatile food and energy items – also came in hotter than anticipated. This development firmed up the Federal Reserve’s interest rate increase trajectory by removing the so-called interest rate hike pause that the market had started to price in for the month of September. As we’ve previously explained, rising interest rates spell trouble for growth-heavy, high beta stocks as they reduce the present value of future cash flows (by increasing the discount rate for such cash flows), thereby reducing the appeal for holding such equities.

We’ve also repeatedly highlighted the ongoing strong correlation regime between growth-heavy US equities and the broader crypto sphere, including Bitcoin and Ethereum, in general. This correlation regime has been bolstered by synchronous liquidation waves that seemingly strike US equities and the crypto sphere in tandem. We’ve previously noted that as long as the current correlation regime holds strong, investors should not expect Ethereum, Bitcoin, and other major cryptocurrencies to bottom out, at least not until US equities also do so. For an inkling as to when this can occur, readers should note that Morgan Stanley’s Michael Wilson now sees the S&P 500 index bottoming out at around the $3,400 price level. With the benchmark index currently trading at the $3,900 handle, sizable downside potential still remains for US equities and the wider crypto sphere.

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DeFi Space Turmoil Spurred by stETH Is Now Spilling Over to Ethereum and the Wider Crypto Arena

Regardless of Cramer’s so-called crypto death knell and the Federal Reserve’s relentless efforts to hammer risk assets in order to subdue the wealth effect pervading the US economy, Ethereum’s latest bout of weakness is at least partially a result of the crypto sector’s endogenous factors.

As a refresher, Lido-staked Ethereum (stETH) is a Decentralized Finance (DeFi) variant of Ethereum that is issued against staked Ethereum coins. stETH can be redeemed for Ethereum on a 1:1 basis but only after the Ethereum 2 transition takes place following the merge event. Therefore, stETH behaves like a stablecoin that is fully backed by Ethereum but without any direct price stabilization mechanism between the two coins. Still, stETH is widely used as collateral in the DeFi space to borrow Ethereum.

This brings us to the crux of the matter. stETH started de-pegging from its theoretical 1:1 ratio with Ethereum on Thursday when Alameda Capital dumped stETH worth around $1.5 billion, reducing its stETH holdings to zero in the process.

Since then, the theoretical peg between stETH and Ethereum could not be restored, with ETH currently trading at $1,228 while stETH is trading at 1,161 right now.

Of course, as stETH’s de-pegging deepens, it can lead to a liquidation of positions that have used stETH as collateral on various DeFi platforms, causing an even more painful de-pegging. While this liquidation has no direct impact on Ethereum, it is severely impacting the sentiment around the world’s second-largest cryptocurrency, resulting in synchronous losses with stETH. In fact, Ethereum has now tumbled to its 2018 highs.

The following Thread explains these dynamics in detail.

Compounding the situation, the crypto lending and staking platform, Celsius, has now halted all user withdrawals, citing “extreme market conditions”. Nonetheless, there are reports that Nexo might purchase some of Celsius’ distressed assets.

Amid this turmoil, the global market capitalization of the crypto sphere has tumbled to below $1 trillion.

Source: https://app.intotheblock.com/coin/ETH/deep-dive?group=all&chart=all

Based on Ethereum’s current price, around 47 percent of its total addresses are still in profit. However, with over 44 percent of the total addresses now sitting on losses, the chances of a disorderly liquidation are ramping up significantly.