ARC: Enable USDT as collateral on Aave V3 (Avalanche) (Re-subbmited)

Governance Maintenance
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ARC: Enable USDT as collateral on Aave V3 (Avalanche)

With the recent depegging of USDC, it has become even more evident that the Aave community needs to seriously reconsider its exposure to specific stablecoins and aim to diversify that exposure and counterparty risk.

This is why we are re-submitting a previous proposal to add USDT as collateral on Aave V3 (Avalanche), with a revised LTV parameter of 50%.

Previous governance proposal: Enable USDT as collateral on Aave v3 on Avalanche

Summary

This is a proposal to enable native USDT (https://tether.to/en/) as collateral on the Avalanche V3 Market.

Motivation

As far as stablecoins go, both DAI and USDC are currently enabled as collateral and we believe that USDT has a similar risk profile and should not be treated differently. Enabling USDT as an additional option for stablecoin collateral on Aave should help safeguard against the inherent risks of any specific stablecoin failing and increasing diversity.

In response to any previous controversies surrounding USDT, Tether has taken significant steps towards increased transparency. It should be seen as a positive that USDT & Tether are under heightened scrutiny, as opposed to many other assets and organizations that are not subject to the same extensive disclosure requirements and regularly undergoing external auditing.

It is important to note that USDT is the oldest and most widely distributed stablecoin in the market. There have been numerous occasions whereby market conditions deteriorated and Tether was able to satisfy all the necessary redemptions.

Driving factors

We believe that an objective analysis of the risks associated with USDT shows that it has a similar risk profile to the other stablecoins listed on Aave & enabled as collateral and that there is no reason why it should only be listed in isolation mode.

As a baseline for our analysis, we will use the risk scale provided in the Aave documentation for evaluating new assets (Methodology - Risk):

What is immediately clear is that USDT scores well in multiple areas as it has been around since 2014 and has remained mostly stable throughout its history. It is also widely adopted and transacted across blockchains and remains the stablecoin with the highest market capitalization.

A point of contention could be Tether’s classification as “centralized but regulated”. Tether claims that it is registered as a money services business with the Financial Crimes Enforcement Network (FinCEN). This is admittedly not equivalent to being regulated by entities such as the New York State Department of Financial Services (NYDFS) like other major stablecoins are. Whether this counts as regulated is ultimately up to interpretation and USDT could also plausibly be classified somewhere between “centralized with audit” and “centralized real-time PoF” on the scale above.

Smart contract risk

Tether has undergone multiple smart contract audits by third party security auditing firms:

CertiK audit: Tether - Web3 Security Leaderboard

OpenZeppelin audit: Tether Token Audit - OpenZeppelin blog

While it is never possible to completely rule out smart contract risk, it’s clear that in the case of USDT, this risk is relatively minimal as the asset does not rely on a complex set of smart contracts like a typical DeFi protocol, which significantly reduces the vector of attack.

Counterparty risk

Counterparty risk is arguably the most significant risk factor to consider in the case of USDT. Tether is the only entity through which USDT can be minted and redeemed by corporate customers and exchanges. This is similar to other centralized stablecoins such as USDC. Due to this level of centralization, Tether has taken steps to increase the transparency of its reserve (see reserves breakdown & audits below) and has been regularly audited.

Market risk

USDT is pegged 1:1 to the US dollar. This is guaranteed by the official minting and redemption process. However, most users acquire and trade USDT through centralized & decentralized exchanges. Given how liquidity pools and AMMs work, there have been instances where USDT has depegged, trading at less than $1 for a short period of time before returning to its peg.

Reserves & other disclosures

Specifications

  • What is the link between the author of the ARC and the Asset?

    • The author of the ARC is a representative of the Ava Labs team.

  • Provide a high-level overview of the project and the token

Launched in 2014, Tether tokens (USDT) pioneered the stablecoin model and are the most widely traded. Tether tokens offer the stability and simplicity of fiat currencies coupled with the innovative nature of blockchain technology, representing a perfect combination of both worlds. USDT is 100 percent backed by Tether’s reserves and Tether tokens have grown in popularity over the past few years, with a market cap of over US$70 billion (as of November 2022). Tether tokens allow customers the ability to transact across different blockchains, without the inherent volatility and complexity typically associated with digital tokens.

  • Explain the positioning of the token in the AAVE ecosystem. Why would it be a good asset to borrow or use as collateral?

    • USDT is a stablecoin that is fully backed by assets that are considered safe cash equivalents with proper levels of liquidity along with stability. Proof of reserves audits for Tether have been done 4 times in 2022 alone and every audit has passed without a single problem. During times when USDT has strayed away from USD peg, users were easily able to buy discounted USDT and redeem it for cash until there was no longer a discount without any issues. USDT is already integrated into multiple DeFi protocols within the Avalanche ecosystem such as Trader Joe, Platypus Finance, Pangolin, Benqi, and Paraswap.

  • Provide a brief history of the project and the different components: DAO (is it live?), products (are they live?). How did it overcome some of the challenges it faced?

    • Founded in July 2014 by Brock Pierce, Craig Sellars, and Reeve Collins, Tether (USDT) is a stablecoin with the intent of tracking the US dollar one to one. Tether was created as an attempt to solve two major issues with existing cryptocurrencies: high volatility and convertibility between fiat currencies and cryptocurrencies. While the tokens themselves operate in a decentralized network, Hong Kong based Tether Ltd is solely responsible for creating and redeeming tokens as well as maintaining the 1:1 deposit backing. Over the years Tether has been a target for false accusations and controversy regarding the assets USDT, but through every market downturn redemptions have all worked as intended and the asset has always restored peg. Within the past year Tether has started to be much more open regarding the assets that back USDT and has had multiple audits performed.

  • How is the asset currently used?

    • Currently, there is about $42M of bridged USDT.e from Ethereum blockchain to the Avalanche ecosystem and $651M of natively minted USDT on Avalanche. The asset currently is integrated into almost every DeFi application from stableswaps like Curve and Platypus, to AMMs like Trader Joe, Pangolin and GMX as well as lending protocols like Benqi, Aave and Joe Lend. The asset is a staple ingrained into the Avalanche network and is one of the most important tokens within every ecosystem.

  • Emission schedule

    • No emission schedule

  • Token (& Protocol) permissions (minting) and upgradability. Is there a multisig? What can it do? Who are the signers?

    • Tether tokens exist as digital tokens built on several leading blockchains, including Algorand, Avalanche, Bitcoin Cash’s Simple Ledger Protocol (SLP), Ethereum, EOS, Liquid Network, Omni, Polygon, Tezos, Tron, Solana and Statemine. These transport protocols consist of open source software that interface with blockchains to allow for the issuance and redemption of Tether tokens. Every Tether token is 100% backed by Tether’s reserves, which includes traditional currency and cash equivalents, and may include other assets and receivables from loans made by Tether to third parties. The Tether platform is fully reserved when the sum of all Tether tokens in circulation is less than or equal to the value of our reserves. Through our Transparency page, anyone can view both of these numbers on a daily basis. Tether tokens (USDT) are created by having multiple Tether private authorization keys sign and broadcast creation transactions on the specific blockchain. These new tokens are “authorized but not issued”, meaning that these USDT are stored in Tether’s treasury and not in circulation until issued in response to market demand. Tether’s multi-signature (or multi-sig) model prevents a single person from issuing USDT on their own, which would represent a single point of failure and a security risk. Tether tokens enable businesses – including exchanges, wallets, payment processors, financial services and ATMs – to easily use fiat currencies on blockchains. Some of the largest businesses in the digital currency ecosystem have integrated Tether tokens.

  • Market data (Market Cap, 24h Volume, Volatility, Exchanges, Maturity)

    • Market Cap: $39B ($693M on Avalanche)

24 Hr Volume: $70B (CEX & DEX) with around a volume of $70m on Avalanche

Exchanges: Trader Joe, Curve, Platypus Finance, GMX, and Pangolin

CoinGecko: Tether Price: USDT Live Price Chart & News | CoinGecko

CoinMarketCap: Tether price today, USDT to USD live, marketcap and chart | CoinMarketCap

Telegram: 7.6k members (Telegram: Contact @OfficialTether)

  • Contracts date of deployments, number of transactions, number of holders for tokens
    • Date of deployment: June 2021 for Ethereum bridged USDT.e on Avalanche and December 2021 for native USDT on Avalanche

The number of transactions: 10.5m on Avalanche

The number of holders: 171,000 on Avalanche

Proposed technical parameters

  • Usage as collateral: Yes
  • LTV: 50%
  • Liquidation threshold: 80%
  • Enabled to borrow: Yes
  • Stable rate enabled: No
  • Liquidation bonus: 5%
  • Reserve factor: 10%

We look forward to discussing this proposal with the Aave community and strongly encourage you to contribute to the discussion and provide feedback. We will be posting a vote on snapshot in 7 days to evaluate the community’s sentiment on this proposal.

References

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USDC survived despite the spectacular collapse of SVB in large part due to the strength of their other partnerships-- the transparency of their Blackrock holdings is about as good as it can get:
Circle Reserve Fund | USDXX | Institutional.

With the recent CFTC targeting of Binance, I think it’s only a matter of time before USDT is in the regulators’ crosshairs. Their opacity and the shady past will come back to haunt them, and when it happens it will result in far more volatility than the SVB-USDC depeg.

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Thanks for putting forward this proposal @Ava_Labs

Based on market risk and liquidity considerations, we support enabling USDT as collateral. Regarding the specific parameters, we suggest keeping the current parameters as they are configured on Aave.

However, it’s important to note that the primary concern, as mentioned in the post, is the counterparty risk. Ultimately, the community must determine its stance on this issue and decide whether to enable USDT as collateral outside of Isolation mode. If the community is supportive of this, the discussion should be expanded to enabling USDT across the other Aave deployments too. Additionally, the community can choose to raise the reserve factor for USDT, which could serve as a form of compensation for the increased risk associated with USDT in comparison to USDC and DAI.

1 Like
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Thanks for the proposal, @Ava_Labs. Gauntlet is analyzing and targets providing analysis within ~1 week.

2 Likes
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Great Proposal @Ava_Labs, thanks for putting this together.

Adding USDT as collateral sounds like the best choice to me. I would even be more aggressive with the LTV, raising it up to 70%.

The reason for my opinion are multiple:

After years in the space, USDT has proven to be resilient beyond measure and the events of the past months has once again proven to be the leader in the centralised stablecoin industry. The outstanding growth in marketcap, compared to the astonishing shrinkage that affected Circle, prove a renewed market confidence in Tether.

With a similar, if not better, risk profile than other centralised stablecoin listed on AAVE, I do not see how listing it as collateral shouldn’t be considered.

Additionally, I believe that tapping in the large whale liquidity that holds USDT, can be a net benefit for the whole AAVE ecosystem.

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I believe these are assumptions, and that the market has be consistently rewarding USDT for their steps to improve the opacity that you mention.

The market belief is actually the exact opposite, as seen by comparing USDC and USDT marketcaps. More and more people are trusting USDT, consolidating their spot as industry leaders in the centralised stablecoin industry.

For reference:

USDT Market Cap:

Screenshot 2023-03-31 at 14.46.49
Screenshot 2023-03-31 at 14.46.491654Ă—936 70 KB

USDC Market Cap:

Screenshot 2023-03-31 at 14.48.04
Screenshot 2023-03-31 at 14.48.041654Ă—936 69.5 KB

Lastly, I believe that diversifying collateral exposure on AVAX can only have a positive effect on the usage of the AAVE protocol.

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… mate, that is quite the cherry picked window for comparison :saluting_face:

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Gauntlet Risk Analysis

Summary

Gauntlet supports the addition of USDT as a collateral asset on Aave v3 Avalanche. Currently, USDT is in isolation mode on the protocol. By removing USDT from isolation mode, we lose utility of the debt ceiling; hence, if removed, we suggest lowering the supply cap for USDT to 160M.

Analysis

From a market risk perspective, USDT has demonstrated its stability throughout various black swan events, including the recent stablecoin volatility.

However, much of the risk associated with USDT is based on general uncertainty around the asset’s risk profile. It is up to the community to determine whether or not they are concerned with this idiosyncratic risk in considering removing USDT from isolation mode. For full transparency, we suggest a supply cap decrease according to a slight adjustment on our borrow and supply cap methodology. Instead of the usual 40% of circulating supply requirement, we will begin with 20% to start. We will follow up with the community shortly after implementation.

Allowing users to diversify their positions by collateralizing positions with other assets may reduce risk, especially pertaining to USDT being in eMode on Avalanche. In isolation mode, users may only borrow USDT, USDC, or DAI, all of which are in the same eMode pool. Recall that USDT is anti-correlated with the other stablecoins in the Stablecoins eMode pool, meaning there is increased liquidation risk. For reference, here are the oracle prices for USDC and USDT on Avalanche this year below. Removing USDT from isolation mode gives sophisticated users a chance to hedge their USDT positions.

As previously discussed, a possible use case of the Stablecoin eMode pool is to enable various trading strategies, including shorting perceived risky stablecoins in the eMode pool. A survey of USDT depositors on Avalanche Aave v3 shows that the top users are not borrowing against their USDT (indeed, there is currently <$1 borrowed against USDT). In contrast, many of the top USDC depositors (such as 0xd45cbf) are borrowing USDT, suggesting that large accounts might be shorting USDT.

This is further corroborated by the relatively high USDT utilization rate across chains – 75% on each of Avalanche, Arbitrum, and Optimism; and 65% on Polygon. Hence, removing USDT from isolation mode could provide users a buffer for liquidations by allowing users to open more diverse positions, as well as reduce the risk of USDT cascading liquidations in the event of a depeg.

Oracle prices for USDC and USDT on Avalanche, 2023:

Oracle prices for USDC and USDT on Avalanche, 2023

Disclaimer:

  • We note that the analysis above only covers market risk and not smart contract risk, regulatory risk, or other technical risks.
1 Like