What is stETH, and what happens to it post-Merge?

It is well-known that the Merge transformed Ethereum, one of the biggest cryptos in the market. But its impact went well beyond the Ethereum blockchain, impacting the entire crypto ecosystem. One of the more noteworthy cryptos to emerge in the context of the Merge is the stETH token.

stETH is an important crypto in relation to the Ethereum ecosystem. In recent times, it even managed to outdo Ether (ETH) in terms of price. This article will help you understand what’s making these tokens so popular, but first a quick refresher on what they are.

What is stETH?

While stETH is short for staked Ether (ETH), it does refer to ETH staked on the Ethereum platform. Yes, you heard that right. Instead, it is the token you get in exchange for staking ETH on Lido, a staking pool.

stETH tokens work a little like the promissory clause on a rupee note, where the rupee holder is promised that the Reserve Bank of India (RBI) will “pay the bearer the sum of” X rupees at a future date. These tokens are similarly meant to assure those who stake or lock up their ETH. But why the assurance? Because the staking is done on the Lido chain. The stETH tokens are therefore meant to promise users that they retain their ownership rights over the ETH staked on this chain.

The difference between stETH and a promissory clause is that stETH’s guarantor is the Lido protocol, which comes with a smart contract system. Not the RBI governor. Users who want to stake their ETH on Lido essentially deposit it into a smart contract. In return, they are given an equivalent amount of stETH. The smart contract is at the heart of Lido’s guarantee.

So, to sum it up, when a deposit is made on Lido, an equivalent amount of stETH is minted. And when stETH is redeemed, it is essentially burned. Theoretically, stETH is supposed to keep pace with the value of ETH.

But why exactly would users deposit their ETH to Lido? The next section will answer that for you.

Why are stETH tokens created, and how is it connected to the Merge?

With the Merge, Ethereum has enabled the option of staking. (That’s what adopting the Proof-of-Stake mechanism means.) Staking is what helps the Ethereum network remain functional and safe now. However, there are two problems that users who want to stake ETH end up facing.

• Problem 1: ETH holders need to stake a minimum of 32 ETH to qualify as a validator. That is a huge number. It is equivalent to $41,458 or ₹34,40,770, as of 20 October 2022. Most investors do not have this huge sum in the first place. And even if they do, it might not make sense to keep it locked away for so long.
• Problem 2: If holders stake ETH on the Ethereum network, they cannot take it out for a long time, which makes trading tough. Besides, to ensure that there is no dumping soon after the Merge, users and validators are not allowed to withdraw their staked ETH tokens 6–12 months post-Merge. That makes matters worse.

Users, therefore, turn to staking pools. Staking pools like Lido solve both the aforementioned problems. Staking pools allow users to pool their crypto so that they can collectively gain access to privileges that they would not be able to access individually. Lido additionally gives users stETH for staking crypto on their network.

Plus, staking on Lido doesn’t involve a minimum lock-in period. So users can liquidate their stETH whenever they want to. Naturally, users want the liquidity that comes with staking ETH on these staking pools. So stETH is part of the solution to problems arising from the Merge.

Besides, it helps the network become more secure and efficient. Win-win.

Can stETH decouple from ETH? What happens if it does?

ETH is supposed to maintain parity with ETH. But can it fail to do this? We received one answer to this question in 2022.

In June this year, stETH was found to be at the heart of Celsius, a well-known crypto lender, halting account withdrawals. The halt had to do with the fact that the crypto lender held tons of stETH, which couldn’t keep up with ETH.

Fears stemming from the Terra crash had been behind the temporary decoupling/depegging. Fear-stricken investors had deposited large quantities of stETH (stored in a wrapped, bridged form) on Anchor and then bridged most of it back to the Ethereum mainnet in just a few days’ time. This resulted in increased selling pressure, which impacted the stETH–ETH peg.

So yes, depegging/decoupling is possible. But if stETH does “depeg” from ETH, it will not behave as a stablecoin would have. Because stETH is designed to function as a liquidity token, it does not have to maintain the 1:1 value ratio with ETH. It works as a coin designed to address liquidity issues even when there is no parity with ETH.

In addition, with the transition to Proof of Stake (PoS) being successful, every stETH will be redeemable for ETH within the next year or two. So, even if stETH decouples again, investors can withdraw their stETH and exchange it for fiat. They can then use the fiat money to repurchase ETH or any other cryptos.

What happens to stETH after the Merge?

After the Merge, stETH remains in existence and performs the same function as before. Those staking their ETH can keep doing it.

For withdrawals, users will need to wait for the hard fork that is scheduled after the Merge. In the meantime, they can exchange their stETH via decentralized exchanges.

But that’s not all there is to know. The Merge will impact the token in some other ways as well. These will be discussed below.

1. Increase in the demand for stETH

Due to the transition to PoS, ETH supply is likely to decrease. And its price is expected to see a hike as a result. The price jump will translate into ETH becoming even more desirable as a store of value and a hedge against inflation. When this happens, a larger number of people will buy ETH and then stake it in order to earn more rewards. As the number of stakers increases, many more will also be looking to exit stakes and be tempted to take the stETH option.

2. Impact on the returns of stakers

The introduction of PoS means that Ethereum’s validators are responsible for proposing new blocks. As a result, they could receive two additional kinds of rewards: priority fees and Maximal Extractable Value (MEV) rewards. Lido will be taking home both of these rewards. So, the rewards that stETH users take away will also rise.

However, the returns will not always stay as high. As these rewards lure more and more validators to join the network, the number of validators on Ethereum also increases. When this happens, the rewards for each validator will decline.

Conclusion

Although stETH has been around since Ethereum’s Beacon Chain Upgrade in December 2020, it only began to gain traction this year. With the Merge sending shivers down the spines of crypto investors, stETH ended up assuming a significant role by offering stakers a liquidity option.

stETH could see some price action in the immediate future, so it’s a crypto to watch out for.

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