[ARC] Stablecoin Volatility Risk Parameter Recomendations

I think precaution is correct here. And it only affects one market for now. Better safe than sorry. Would aave be way bigger and had a way bigger treasury I would say it’s not necessary but Aave is still young and needs to grow till it’s mature enough to handle every situation or can repay bad debt fully.

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Quick update from the Chaos war room - we are conducting an ongoing analysis of the situation throughout the day, focused on assessing an alternative path forward to pausing all V2 and V3 markets.

Pausing all markets is clearly a robust risk-mitigating step regarding a momentary/temporary depeg of stablecoins. However, it may lead to bad debt from the inability to liquidate other (non-stablecoin) assets in a case of a broader market downturn. With SVB’s collapse and USDC’s exposure coming to the forefront of markets on Friday, we may see a spike in volatility across markets globally.

To this end, we’re conducting a holder and position analysis across V2 and V3 deployments and simulating different price drop trajectories across various asset classes. We aim to quantify potential loss for these scenarios, which will help provide a holistic recommendation on the path forward. We will share our conclusions after completing this research and further analysis.

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Update: Gauntlet is in touch with community contributors. Under certain conditions, Gauntlet proposes pausing all stablecoins on Aave V3 markets that have emode (Arbitrum, Optimism, Avalanche, and Polygon). Most importantly Avalanche and Polygon should be paused if those situations occur.

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We support freezing USDC, USDT, DAI, FRAX, and MAI on Aave V3 Avalanche and set the LTV to 0. This will minimize additional risks in case of further de-pegging, not only USDC.

We believed that as of now, we should not fully pause all the supply/borrow markets. We should do a risk assessment across all V2 and V3 deployments.

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Thanks, @BristolBlockchain. To clarify - freezing those assets only mitigates risk against new positions, not existing ones, which are already sizable in e-mode markets.

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Thank you for your clarification @Pauljlei. But we cannot control the existing position right? i.e. it’s based on the position’s owner to pay out the debt. Can you give your reasoning?

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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:

  1. Unpaused: USDC/DAI reaches 0.85 prices, causing over 2 million bad debt (and a sharp bad debt accumulation thereafter)

  2. 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:

  1. USDC regains its peg.
  2. 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:

  1. We don’t identify any strong evidence to support that
  2. 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.

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For clarity - Gauntlet currently recommends not pausing the market, as a result of the changed conditions since when we recommended pausing here (Gauntlet’s recommendation to pause the market was not implemented at the time we made that recommendation). We may recommend pausing the stablecoin markets under certain thresholds.

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Thank you @ChaosLabs for sharing this. We are still in favor of freezing the stable markets and setting LTV to 0. We should act immediately as freezing require governance voting.

For other markets, we should monitor and update accordingly.

Gauntlet Market Update (3/12/2023 12:30PM ET)

To be more specific on Gauntlet’s recommendation above, if we see the price of USDC drop to 0.91 cents again, Gauntlet proposes pausing all stablecoins on Aave V3 markets that have emode (Arbitrum, Optimism, Avalanche, and Polygon) which will stop liquidations on all assets.

Overview

USDC recently broke from its $1 peg and prices dropped as low as $0.88. When this happened, liquidations began to fail on multiple Aave markets. USDC e-mode was affected the most, with realized losses of ~$180k. Liquidity for USDC is still much below normal levels. We worked with the AAVE Guardians to suggest a few paths forward. Currently, Aave has frozen the stablecoin markets on Avalanche V3. Unlike pausing, this doesn’t prevent the insolvencies we were worried about, but since the USDC price has recovered, we are not recommending further action at this time. We will let the community know when we are ready to restore full functionality to these markets.

Key Metrics

Key Risks

1 - Price dip and recovery

If the price dips and recovers, liquidations will only process on the way up. Rational liquidators will not take on USDC collateral until they are confident they can unload it. This is exactly what we saw play out in the last dip on Friday - you only get adverse liquidations

Many Aave community participants expect USDC to eventually recover to close to a dollar. If price drops below 0.91, adverse liquidations could exacerbate insolvency in e-mode markets like Avalanche. If we see the price of USDC drop to 0.91 cents again, we propose pausing all stablecoins on Aave V3 markets that have emode (Arbitrum, Optimism, Avalanche, and Polygon) which will stop liquidations on all assets. Most importantly Avalanche and Polygon need to be paused if this situations occurs.

2 - Price stabilizes at a lower level

In the case that the price falls and stabilizes well below a dollar, we do not expect liquidations to process normally given current liquidity levels. In this case, the protocol will suffer a loss. If prices continue to drop, we may recommend pausing as well as freezing.

Current Gauntlet Recommendations

vn Market Size New Bad Debt Status Recommendation Notes
V3 Ethereum $0.3B $0 No Changes Made No action needed
V3 Avalanche $0.24B $179,750 - Stablecoin LTVs set to 0

- Stablecoins frozen

Standby See below
V3 Polygon $0.11B $3,250 No Changes Made Standby
V3 Arbitrum $0.061B $21,930 No Changes Made Standby
V3 Optimism $0.077B $0 No Changes Made Standby
V2 Ethereum $5.2B $10,000 No Changes Made No action needed
V2 Avalanche $0.055B $0 No Changes Made No action needed
V2 Polygon $0.205B $0 No Changes Made No action needed

For Avalanche:

  • Loss due to adverse liquidations after USDC price recovery. Changes summarized here. If USDC price begins to drop again, we may want to disable liquidations on USDC if possible. Otherwise, when prices stabilize, we can turn the market back to full functionality

Current Initiatives

Initiative Status ETA Updates
Market Monitoring In Progress 3/14/23 PM* Market montioring is part of our Risk Management service. We are monitoring all markets closely and will notfiy stakeholders as markets change.
Risk Recommendations In Progress 3/14/23 PM* We will continue to provide recommendations to the community and Guardians as conditions change in case drastic action needs to be taken.
Calls and communications to explain risk with Gaurdian / stakeholders Complete 3/11/23 AM
Initial Analysis Complete 3/10//23 PM Our initial analysis was complete early evening on 3/10 and communicated to stakeholders as soon as Gauntlet's analysis predicted that adverse liquidations would happen
Initial forum post Complete 3/10/23 PM Link here
  • * This is the current best guess for when clarity on USDC value will be provided - we will monitor and provide recommendations as necessary beyond that date
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Market conditions have been trending positively in the past 24 hours, with the most recent news that SVB deposits will be accessible Monday, leading to USDC nearly restoring its peg. Therefore, we stay consistent with our recommendation not to pause any markets and will not be advancing the market freeze or LTV recommendations.

Having said that, as we’ve observed over the weekend, market conditions can change drastically over short time frames. We will continue to monitor market conditions diligently and will update the community with new data or market dynamics that may lead to a different course of action.

Chaos Labs is still in a war room and available 24/7. Please reach out if you have any questions or concerns.

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Gauntlet Market Update (3/12/2023 11:30PM ET)

Overview

In our previous update (12:30PM ET), Gauntlet communicated that we no longer recommended pausing additional markets, unless the price of USDC dropped to $0.91.

Additionally, while the Treasury, Federal Reserve, and FDIC have stepped in to insure the deposits for SVB and Circle’s other key banking partners, we are still waiting for markets to open and prices to stabilize before we will resume normal operation. In the meantime, we will continue monitoring and driving the other initiatives below.

Gauntlet’s estimate of USDC redemption rates by custody provider

Key Metrics

Key Risks

1 - Price dip and recovery

If the price dips and recovers, liquidations will only process on the way up. Rational liquidators will not take on USDC collateral until they are confident they can unload it. This is exactly what we saw play out in the last dip on Friday and Saturday - you only get adverse liquidations

Many Aave community participants expect USDC to eventually recover to close to a dollar. If price drops below 0.91, adverse liquidations could exacerbate insolvency in e-mode markets like Avalanche. If we see the price of USDC drop to 0.91 cents again, we propose pausing all stablecoins on Aave V3 markets that have emode (Arbitrum, Optimism, Avalanche, and Polygon) which will stop liquidations on all assets. Most importantly Avalanche and Polygon need to be paused if this situations occurs.

2 - Price stabilizes at a lower level

In the case that the price falls and stabilizes well below a dollar, we do not expect liquidations to process normally given current liquidity levels. In this case, the protocol will suffer a loss, but there is little to do here except freezing the stablecoin markets, which already has been done.

Current Gauntlet Recommendations

No action is recommended right now. Several markets are on standby.

vn Market Total Market Size New Bad Debt Status Recommendation Notes
V3 Ethereum $0.62B $0 No Changes Made No action needed
V3 Avalanche $0.36B $259,000 - Stablecoin LTVs set to 0

- Stablecoins frozen

Standby See below
V3 Polygon $0.18B $3,000 No Changes Made Standby
V3 Arbitrum $0.104 B $22,000 No Changes Made Standby
V3 Optimism $0.087B <$1000 No Changes Made Standby
V2 Ethereum $6.03B $10,000 No Changes Made No action needed
V2 Avalanche $0.055B $0 No Changes Made No action needed
V2 Polygon $0.205B $0 No Changes Made No action needed

For Avalanche:

  • Loss due to adverse liquidations after USDC price recovery. Changes summarized here. If USDC price begins to drop again, we may want to disable liquidations on USDC if possible. Otherwise, when prices stabilize, we can turn the market back to full functionality

Current Initiatives

Initiative Status ETA Updates
Market Monitoring In Progress 3/14/23 PM* Market montioring is part of our Risk Management service. We are monitoring all markets closely and will notify stakeholders as markets change.
Risk Recommendations In Progress 3/14/23 PM* We will continue to provide recommendations to the Guardians as conditions change in case drastic action needs to be taken.
Calls to explain risk with stakeholders Complete 3/11/23 AM
Initial Analysis Complete 3/10//23 PM Our initial analysis was complete early evening on 3/10 and communicated to stakeholders as soon as we verified e-mode liquidations might fail.
Initial forum post Complete 3/10/23 PM Link
Update for forums, 3/12 Complete 3/12/23 PM Link
  • * This is the current best guess for when we will get clarity on USDC value - we will monitor and provide recommendations as necessary beyond that date
3 Likes

Gauntlet Market Update (3/13/2023 12:30PM ET)

In our previous update (Mar 12, 2023 11:30PM ET), Gauntlet communicated that we no longer recommended pausing additional markets, unless the price of USDC dropped to $0.91.

Additionally, while the Treasury, Federal Reserve, and FDIC have stepped in to insure the deposits for SVB and Circle’s other key banking partners, we are still waiting for markets to open and prices to stabilize before we will resume normal operation. In the meantime, we will continue monitoring and driving the other initiatives below.

Overview

In our previous update (12:30PM ET), Gauntlet communicated that we no longer recommended pausing additional markets, unless the price of USDC dropped to $0.91.

Additionally, while the Treasury, Federal Reserve, and FDIC have stepped in to insure the deposits for SVB and Circle’s other key banking partners, we are still waiting for markets to open and prices to stabilize before we will resume normal operation. In the meantime, we will continue monitoring and driving the other initiatives below.

Gauntlet’s estimate of USDC redemption rates by custody provider

Key Metrics

Key Risks

1 - Price dip and recovery

If the price dips and recovers, liquidations will only process on the way up. Rational liquidators will not take on USDC collateral until they are confident they can unload it. This is exactly what we saw play out in the last dip on Friday and Saturday - you only get adverse liquidations

Many Aave community participants expect USDC to eventually recover to close to a dollar. If price drops below 0.91, adverse liquidations could exacerbate insolvency in e-mode markets like Avalanche. ** If we see the price of USDC drop to 0.91 cents again, we propose pausing all stablecoins on Aave V3 markets that have emode (Arbitrum, Optimism, Avalanche, and Polygon) which will stop liquidations on all assets. Most importantly Avalanche and Polygon need to be paused if this situations occurs. **

2 - Price stabilizes at a lower level

In the case that the price falls and stabilizes well below a dollar, we do not expect liquidations to process normally given current liquidity levels. In this case, the protocol will suffer a loss, but there is little to do here except freezing the stablecoin markets, which already has been done.

Current Gauntlet Recommendations

No action is recommended right now. Several markets are on standby.

vn Market Total Market Size New Bad Debt Status Recommendation Notes
V3 Ethereum $0.62B $0 No Changes Made No action needed
V3 Avalanche $0.36B $259,000 - Stablecoin LTVs set to 0

- Stablecoins frozen

Standby See below
V3 Polygon $0.18B $3,000 No Changes Made Standby
V3 Arbitrum $0.104 B $22,000 No Changes Made Standby
V3 Optimism $0.087B <$1000 No Changes Made Standby
V2 Ethereum $6.03B $10,000 No Changes Made No action needed
V2 Avalanche $0.055B $0 No Changes Made No action needed
V2 Polygon $0.205B $0 No Changes Made No action needed

For Avalanche:

  • Loss due to adverse liquidations after USDC price recovery. Changes summarized here. If USDC price begins to drop again, we may want to disable liquidations on USDC if possible. Otherwise, when prices stabilize, we can turn the market back to full functionality

Current Initiatives

  • * This is the current best guess for when we will get clarity on USDC value - we will monitor and provide recommendations as necessary beyond that date
Initiative Status ETA Updates
Market Monitoring In Progress 3/14/23 PM* Market monitoring is part of our Risk Management service. We are monitoring all markets closely and will notify stakeholders as markets change.
Risk Recommendations In Progress 3/14/23 PM* We will continue to provide recommendations to the Guardians as conditions change in case drastic action needs to be taken.
Calls to explain risk with stakeholders Complete 3/11/23 AM
Initial Analysis Complete 3/10//23 PM Our initial analysis was complete early evening on 3/10 and communicated to stakeholders as soon as we verified e-mode liquidations might fail
Initial forum post Complete 3/10/23 PM Link
Update for forums, 3/12 Complete 3/12/23 PM Link
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Hi all - Wanted to get a bit more of an understanding why the Avalanche market remains frozen. Stablecoins have traded more than $20M in volume in stableswap pairs alone yesterday and so it is unclear where the specific risk is and especially to Avalanche only. Thank you!

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Considering that prices stabilized, from our perspective seems reasonable for the Guardian to revert the freezing and we can create the technical payload for it.

But first, we would like to have confirmation/not from both Gauntlet (@Pauljlei ) and Chaos Labs (@ChaosLabs) regarding any risk considerations.

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With markets stabilizing after the weekend events, Chaos Labs support an immediate unfreezing of the V3 Avalanche reserves.

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As prices have stabilized, and local liquidity has recovered to pre-crisis levels, unfreezing the USDC market on Avalanche would return the protocol to a similar risk level to last week. However, the Avalanche market is one of the higher-risk markets for Aave. On-chain liquidity is crucial to successful liquidations on Avalanche, and is still limited. That being said, Gauntlet supports unfreezing the markets, though we remain cautious and will continue to monitor liquidity conditions.

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In my opinion, unfreezing the markets on Avalanche side should be done. All prices are stabilized, so there should not be any problem.

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Hi all, so any idea why the Avalanche market remains frozen? It took a couple hours to freeze it and now two days have passed since everyone agreed it was ok to revert it. This issue is affecting users and the reputation of the protocol. Also if something is indeed going on a little bit of communication wouldn’t hurt so people know what to expect (couple hours, couple days, couple weeks?).

The Avalanche markets have been unfrozen. Thank you to everyone who contributed during this time of uncertainty.

Gauntlet has provided a full retro on how the Aave protocol performed during the stablecoin volatility here, including the actions taken by the community to combat the risks. We encourage anyone interested in learning more about this unique market event to review.

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