What you need to know about staked ether, the token at the center of crypto’s liquidity crisis

Another controversial cryptocurrency is causing havoc in the digital asset market — and this time, it’s not a stablecoin.

Staked ether, or stETH, is a token that’s supposed to be worth the same as ether. But for the past few weeks, it has been trading at a widening discount to the second-biggest cryptocurrency, fanning the flames of a liquidity crisis in the crypto market.

On Friday, stETH fell as low as 0.92 ETH, implying an 8% discount to ether.

Here’s everything you need to know about stETH, and why it has crypto investors worried.

Each stETH token represents a unit of ether that has been “staked,” or deposited, in what’s called the “beacon chain.”

Ethereum, the network underpinning ether, is in the process of upgrading to a new version that’s meant to be faster and cheaper to use. The beacon chain is a testing environment for this upgrade.

Staking is a practice where investors lock up their tokens for a period of time to contribute to the security of a crypto network. In return, they receive rewards in the form of interest-like yields. The mechanism behind this is known as “proof of stake.” It’s different from “proof of work,” or mining, which requires lots of computing power — and energy.

To stake on Ethereum currently, users have to agree to lock away a minimum 32 ETH until after the network upgrades to a new standard, known as Ethereum 2.0.

However, a platform called Lido Finance lets users stake any amount of ether and receive a derivative token called stETH, which can then be traded or lent on other platforms. It is an important part of decentralized finance, which aims to replicate financial services like lending and insurance using blockchain technology.

StETH isn’t a stablecoin like tether or terraUSD, the “algorithmic” stablecoin that collapsed last month under the strain of a bank run. It’s more like an IOU — the idea being that stETH holders can redeem their tokens for an equivalent amount of ether once the upgrade completes.

When the Terra stablecoin project imploded, stETH’s price began trading below ether’s as investors raced for the exit. A month later, crypto lender Celsius started halting account withdrawals, which saw stETH’s value dropping even further.

Another company with exposure to stETH is Three Arrows Capital, the crypto hedge fund which is rumored to be in financial trouble. Public blockchain records show that 3AC has been actively selling its stETH holdings, and 3AC co-founder Zhu Su has previously said his firm is considering asset sales and a rescue by another firm to avoid collapse.

3AC was not available to comment when contacted by CNBC.

Investors worry that the fall in stETH’s value will hit even more players in crypto.

“In crypto there is no central bank,” Shea said. “Things will just have to play out, and it will continue to weigh on crypto asset prices, compounding the negative impact from the macro backdrop.”

Bitcoin briefly sank below $18,000 a coin on Saturday, pushing deeper into 18-month lows. It’s since recovered back above $20,000. Ether at one point dropped below $900, before retaking $1,000 by Monday.

The stETH debacle has also led to fresh concerns over the security of Ethereum. About a third of all the ether locked into Ethereum’s beacon chain is staked through Lido. Some investors worry this may give a single player too much control over the upgraded Ethereum network.

Ethereum recently completed a dress rehearsal for its much-anticipated merge. The success of the event bodes well for Ethereum’s upgrade, with investors expecting it to take place as early as August. But there’s no telling when it will actually happen — it’s already been delayed numerous times.