Rival crypto lenders moved quickly to distance themselves from staked ether (stETH) on Monday after Celsius Network paused all client withdrawals to stabilize its liquidity position.

Staked ether is a form of ether (ETH) offered by Lido Finance that allows staked crypto to be used in other trades in a process known as liquid staking. BlockFi CEO Zac Prince tweeted it has “zero stETH exposure” and Kiril Nikolov, decentralized finance (DeFi) strategist at Nexo, told The Block that Nexo holds only a "limited number of stETH."

So why all the excitement about staked ether?

Celsius, a centralized platform, works to offer returns to its customers. These yields come from various DeFi lending activities, where it makes uses of its own client funds to earn additional income. Celsius's terms and conditions state user deposits act as loans which the platform can use however they like.

On-chain activity shows that Celsius transferred clients' ether into Lido Finance, a liquid staking protocol which lets ETH holders stake on the Ethereum Beacon Chain to earn direct staking rewards. The protocol gives back stETH, a token that unlocks the underlying capital so it can be reused as collateral on other DeFi projects.

Why is staked ether important?

We know from on-chain data that Celsius took large amounts of ETH and staked it on the Beacon Chain via Lido Finance. It then deployed the underlying stETH collateral for additional yield generation.

Recently, though, stETH faced liquidity issues on Curve Finance, a decentralized exchange, where the stETH is traded against ETH, usually at the ratio of 1:1. That ratio has now become unbalanced, causing a liquidity crunch for Celsius.

An analysis of Celsius wallets from Larry Cermak, The Block’s VP of Research, shows that Celsius holds at least 409,170 stETH in its wallets, worth about $463 million.

Meanwhile, the Curve pool contains 120,613 ETH paired against 515,018 stETH, which is highly unbalanced ratio of 19% ETH to 81% stETH. This mismatch has led to an operational crisis, making it very hard for Celsius to convert their stETH holdings back to ETH to meet user withdrawal requests for the asset.

“Celsius owned so many stETH tokens that it is close to impossible to convert back to ETH without finding a counterparty via OTC,” said Eden Au, Research Director at The Block, referring to over-the-counter trading, where counterparties are matched away from an exchange.

To make matters worse, stETH has lost its supposed parity with ETH and has been trading under a ratio of 0.95. The end situation is a catch 22 for Celsius where it can’t sell stETH on Curve, unless it wants to further push its price down and jeopardize the value of its own customer funds.

Celsius didn't immediately respond to a request for comment on its investments. Lido Finance didn't immediately comment on the role of stETH in the situation.

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