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:
Disclaimer:
- We note that the analysis above only covers market risk and not smart contract risk, regulatory risk, or other technical risks.