[ARC] - ERC4626 Strategies as Productive Collateral

[MatthewGraham]

Hi @Pauljlei,

@Pauljlei

The user strategy is to deposit BPT, borrow ETH, stake their ETH, get wstETH, deposit wstETH into the Balancer pool, and repeat as much as possible to get leveraged yield.

The above is unlikely to be the most economic strategy. I believe a proposal will emerge that requests enabling borrowing on wstETH. It then becomes more economic to borrow wETH and wstETH which is then deposited into Balancer.

A user who attains the wstETH/wETH BPT can deposit into Aave, borrow ETH and wstETH on Aave v3 Ethereum, then deposit into Balancer pool to receive the BPT which can then be deposited as collateral again. This recursive strategy, leverages swap fees, bb-a-USD, AURA and BAL rewards from the Aura Finance gauge. There is no need to interact with the Lido staking deposit contract.

@Pauljlei

First, if ETH interest rate curve isn’t high enough, then this won’t prevent high ETH utilization on V3 (the BPT strategy may be highly profitable, so the cost of borrowing ETH has to be very high until the strategy is no longer profitable), and high ETH utilization can interfere with atomic liquidations (for user positions that are using ETH as collateral). Also, there’s the standard issue of inhibiting users from withdrawing their ETH from the pool.

This is a parameter within the Aave governance control and something Llama can actively manage. It is not a barrier but rather a consideration much like similar Reserves on various Aave deployments.

@Pauljlei

Second, if wstETH is already listed on V3 at that time when BPT for wstETH/wETH is listed, then under high ETH utilization, the high ETH borrow rate can put stress on the existing wstETH/ETH yield farmers on Aave V3 (at that time) who are depositing wstETH as collateral and borrowing ETH.

There are numerous bb-a-wETH Linear Pools coming which will provide liquidity to the Ethereum v3 market. However, as you point out there are natural market forces at play. This to me is more stating we expect actors to be rational and profit driven, therefore users will leverage the BPT. Do note, there is always ETH and stETH liquidity on other DEXs which can be used to support liquidations. There are also likely to be other communities building something similar and it is therefore unlikely all of the BPT will be deposited into Aura Finance gauges via Aave.

@Pauljlei

Third, if the utilization for ETH is high on V3 and the supply rate becomes attractive, this may incentivize users to withdraw ETH supply from Aave V2 and deposit it on V3 instead. The elasticity would depend partly on how the interest rate curves are configured. But if we imagine a scenario where a significant amount of ETH on V2 is withdrawn and supplied on V3 instead, ETH utilization on Aave V2 will spike. Now, the interest rate on ETH on V2 can put stress on existing stETH/ETH yield farmers on V2. You may argue that the additional supply that transitioned from V2 to V3 now alleviates the ETH utilization problem on V3, but that is not certain, and additional borrowing on V3 may fully utilize the additional supply depending on the interest rates. Additionally, you may argue that the high interest rate on V2 will attract more ETH supply on V2, but again, the elasticity is difficult to predict.

This highlights a risk that is within Aave’s controls. It is fair to assume v2 markets should have the support of the Safety Module disabled, borrowing disabled and overtime the Reserve Factor can be increased to encourage liquidity to transit to v3 deployments. Reducing the LTV of old markets risk liquidating user’s positions and therefore an unfavourable path forward.

Similar to @AaveLabs, I believe the intent will be proceed with enabling the collateral type and then presenting a proposal to list a BPT. The community can consider if to list the BPT at that point in time. All of the points mentioned by Gauntlet are already known and there is plenty of time to create a lower risk environment across Aave Liquidity Pools. As mentioned in the proposal, the Snapshot is indicative of what Llama intends to build, although I believe Aave Companies proposal is approaching audit.