USDC Pause pros and cons
TLDR;
Our recommendation for all deployments currently is not to pause. With the peg restoring, we believe there is a higher risk of incurring bad debt due to non-stable (WBTC, WETH) volatility compared to the threat of a USDC/DAI depeg to 0.85 prices and below.
The inflection point of large bad debt is in the following scenarios:
-
Unpaused: USDC/DAI reaches 0.85 prices, causing over 2 million bad debt (and a sharp bad debt accumulation thereafter)
-
Paused Markets: Nonstables (BTC, WETH, etc.) price drops over 40%, causing over $2 million in bad debt (and sharp bad debt accumulation thereafter).
Risk Scenarios
When assessing the situation, we’re addressing the following scenarios:
- USDC regains its peg.
- USDC keeps trading around the current discount level.
These scenarios may include a momentary depeg much more significant than the current level.
We are not accounting for a scenario in which USDC completely loses its peg for 2 major reasons:
- We don’t identify any strong evidence to support that
- This would encourage decreasing USDC and DAI exposure as fast as possible, even at the cost of losses. Given that we do not see this as a likely scenario. The damage here can be greater than the reward.
Pausing Assets - Pros and Cons
We have evaluated the possibility of pausing or freezing assets to mitigate protocol risk. The main risks are listed by order of significance, 1 being the riskiest and 5 being the least risky.
For AAVE V3 Deployments:
V → No new risk introduced, subject to market movements
X → New Risk exposure due to stable depeg or new reserve configuration
Disabling stable collateral (LTV=0), Governance Vote Required | Freezing Stables, Governance Vote Required | Pausing Stables | Pausing All | |
---|---|---|---|---|
1. Toxic In-Flow Risk - New Positions (net new USDC dumped into Aave) | V | V | V | V |
2. Toxic In-Flow Risk - Existing Positions | X | X | V | V |
3.a. Bad Debt from Liquidations of stablecoins | X | X | V | V |
3.b. Bad Debt from other assets | V | V | V | X (liquidations cannot be made as a function of market movements) |
4. Leverage Increase by Collateral Withdrawals | X | X | V | V |
5. Leverage Increases by increasing borrows | X | X | X | V |
For AAVE V2 deployments:
Disabling stable collateral (LTV=0) | Freezing Stables | Pausing All | |
---|---|---|---|
1. Toxic In-Flow Risk - New Positions (net new USDC dumped into Aave) | V | V | V |
2. Toxic In-Flow Risk - Existing Positions | X | X | V |
3.a. Bad Debt from Liquidations of stablecoins | X | X | V |
3.b. Bad Debt from other assets | V | V | |
4. Leverage Increase by Collateral Withdrawals | X | X | V |
5. Leverage Increases by increasing borrows | X | X | V |
Analysis
Markets Not Paused -Stablecoin Depeg (worst case - liquidation of entire collateral)
Markets Paused (Assuming re-peg) - Loss due to disabling Liquidations Incurred During Volatile Asset Price Crash
Recommendation
V2 Deployment
- Don’t pause currently; continue monitoring and updating as a function of market changes.
- Freeze stable markets, set LTV to zero
V3 Deployments
- Don’t pause currently; continue monitoring and updating as a function of market changes.
- Freeze Stables set LTV to zero.
It is important to note that pausing can be introduced via Admin functionality anytime. However, freezing markets requires a governance process and can take several days. Where possible (like Avalanche), we recommend freezing immediately.