tl;dr
Ethereum's validator exit queue has surged dramatically since July 16 due to structural stresses, notably a spike in ETH borrow rates on Aave from 2-3% to 18% following liquidity issues linked to HTX exchange withdrawals. This caused leveraged staking strategies using Liquid Staking Tokens (LSTs) an...
Ethereum’s validator exit queue has swelled dramatically since July 16, driven by structural stresses rather than speculative profit-taking. A sharp increase in ETH borrow rates on Aave, triggered by a liquidity crunch after large withdrawals linked to the HTX exchange, caused borrow rates to spike from 2-3% to as high as 18%. This rate hike flipped the spread between ether staking yields and borrowing costs negative, rendering leveraged staking strategies unprofitable almost overnight.
These looping strategies involve using Liquid Staking Tokens (LSTs) or Liquid Restaking Tokens (LRTs) as collateral to borrow ETH, which is then redeposited to amplify staking yields. When borrowing costs surpassed staking returns, participants scrambled to unwind positions by repaying loans and reclaiming ETH collateral. This unwinding intensified selling pressure on LSTs and LRTs, pushing their discounts against ETH wider and triggering a flood of unstaking requests that overwhelmed Ethereum’s intentionally throttled exit queue.
The validator exit queue, limited to 8-10 exits per epoch to maintain consensus stability, ballooned from fewer than 2,000 validators to over 475,000 in just days, increasing wait times from under an hour to more than eight days. This surge outpaced previous episodes like the Celsius-driven withdrawals in January 2024. Some traders exploited discounted LSTs and LRTs, purchasing them and redeeming at full ETH value, further congesting the queue.
Despite the spike in unstaking activity, overall ETH staking demand remains robust, with validator entry queues reaching their highest levels since April 2024, nearly offsetting exit volumes. This indicates that while selling pressure is intense, confidence in Ethereum staking persists.
The episode exposed the liquidity fragility of the LST and LRT ecosystems under extreme conditions, especially when leveraged strategies are involved. It underscored the necessity for new solutions to manage duration and redemption risks, including peer-to-peer exit markets and protocol-native liquidity vaults, which could smooth capital flows during exit surges and help stabilize the network.