A report released Wednesday by blockchain research firm Nansen draws a straight line from Terra to the sinking price of lido staked ether (stETH). The report also zooms in on Three Arrows Capital (3AC) and Celsius for their dual roles as both catalysts and casualties for the broader crypto market decline.

As crypto markets tumble and firms like Three Arrows Capital and Celsius appear on the brink of insolvency, all eyes have shifted to stETH, a derivative token of ether (ETH). Until recently, both had traded at around the same price.

Widely publicized stETH sales by 3AC, Celsius and others, however, played a role in pushing stETH’s price sizably below that of ETH. At press time, stETH traded at a 4% discount to ETH, according to CoinMarketCap.

In its report, Nansen contends that the seeds of stETH’s decline were planted long before the wider crypto market crash in early June. Nansen’s analysis shows how the stETH “de-peg” can be traced back to the implosion of the Terra stablecoin ecosystem at the start of May.

In pinning stETH’s collapse on Terra, the report painted the ill-fated stablecoin project – whose UST and Luna token crashes wiped out $40 billion back in May – as "patient zero" for a crypto contagion that continues to wreak havoc across sector balance sheets.

Lido staked ether, which represents ether “staked” on Ethereum’s proof-of-stake Beacon Chain, has become a key tool underlying the budding decentralized financial ecosystem (DeFi). It enables users to earn rewards for helping to secure Ethereum’s Beacon Chain – which will soon merge with the network’s main network – without losing the ability to trade ether (ETH).

“Although the talks about stETH 'de-pegging' have been most present recently, the groundwork for the current situation was laid around one month earlier – during the UST collapse,” said Nansen.

When Terra’s UST stablecoin was still priced at $1, a popular investment strategy involved moving stETH over to Terra’s blockchain using Wormhole, a popular “bridge” for moving assets between chains. Once the stETH was on Terra, it was represented by a derivative token called bETH, which could be deposited into a lending platform called Anchor in order to borrow UST.

This stETH-to-UST transmutation strategy was working well enough until UST’s price started to falter. As investor confidence in Terra dipped, Anchor users rushed to claw their bETH out of the platform. From there, they bridged the Terra-based bETH back to Ethereum and converted it back to stETH.

As Nansen explained in its report: “From May 7, Wormhole's bETH holdings fell from a peak of 667k to 32k within four days - a 95% drawdown. Similarly, Anchor's vault also experienced an abrupt fall of over 96% from its high of 665k stETH to 26k stETH. This reduction is analogous to flows from Terra to Ethereum, as investors were immediately unwrapping their bETH for stETH after bridging back.”

From here, Nansen says many users opted to sell their stETH back for ETH, which had the effect of depressing stETH’s price. Most stETH sellers, according to Nansen, dropped their tokens onto Curve – a stablecoin-focused decentralized exchange (DEX). “The net stETH buy/sell during this period reveals that a net cumulative of over 169k stETH were sold on DEXs (primarily on Curve),” Nansen recounted.

The massive inflows of stETH and outflows of ETH from Curve ended up crashing stETH’s price on its largest money market.

Nansen pointed to Celsius and Three Arrows Capital as the two firms likely to have had the largest impact on decreasing stETH’s price in the days following Terra’s collapse. Their main effect came from decreasing the number of tokens in Curve liquidity pools – buckets of currencies that decentralized exchanges use to facilitate swaps between tokens.

Nansen: “On May 12, Three Arrows Capital removed $400m of liquidity (128k stETH + 73k ETH) from the stETH/ETH Curve pool in a single transaction. Meanwhile, Celsius took out $380m of liquidity on the same day in three separate transactions.”

Shrinking liquidity pools can contribute to something called “slippage,” which can make large DEX trades prohibitively expensive. With Curve as the primary market for stETH, Nansen said 3AC’s and Celsius’ withdrawals made it difficult for others to exit their positions due to slippage and skewed stETH’s price.

“Other participants were also observed withdrawing liquidity, but these two entities were most consequential to the pool's health,” the report said.

While they may have contributed to stETH’s price dip, Nansen’s said Celsius and Three Arrows also suffered immensely as a result of stETH’s persistent price discount – especially as the broader crypto market collapsed at the start of June.

Celsius, a crypto lender that was at one point a major investor in Terra, has paused customer withdrawals and, according to the The Wall Street Journal, is now facing potential bankruptcy due to a series of failed DeFi bets.

“Given the poor market backdrop post-Terra’s collapse, both pool imbalance and liquidity on Curve for stETH failed to recover; the drying up of liquidity meant that there was no other avenue for significant stETH holders such as Celsius to cover their positions, culminating in the widely publicized events that occurred on June 11-13,” Nansen said.

Three Arrows Capital also invested in Terra and was once a darling in DeFi investor circles. It became a pariah this month after failing to pay back creditors – apparently due to questionable risk management practices. On Wednesday, CoinDesk reported that a British Virgin Islands court is forcing the firm into liquidation.

According to Nansen, “3AC’s lack of sound risk management coupled with excessive leverage was simply a ticking time bomb that was set off by the stETH ‘de-peg.’”

Celsius and 3AC are just the latest (and most prominent) casualties in the recent crypto decline. Should stETH’s price continue to fall, one should expect to see far more knock-on effects.

In its report, Nansen said that a number of traders have engaged in high-leverage strategies built atop the assumption that ETH and stETH will trade 1:1.

One popular strategy involves borrowing ETH against stETH on the DeFi lending platform Aave, staking that ETH in exchange for more stETH, and then depositing that new stETH into Aave, and then continually repeating the process. This popular strategy increases the rewards one can receive for staking ether, but it also increases one’s exposure to stETH in the event of a price decline.

As Nansen explains, “The tradeoff is the build-up of leveraged positions which can be liquidated if stETH trades at a significant discount against ETH, putting the stETH at risk of a potential liquidation cascade when there is enough selling pressure. Once the selling pressure starts to mount, more users will have to sell their stETH to cover their positions, further exacerbating the sell pressure.”