Overview
The motivation to add cbETH to E-Mode is high, as it is a fast-growing LSD with a market cap well above $1B over time. Adding cbEth to E-Mode will contribute significantly to making Aave the protocol of choice to utilize LSDs and cbETH, specifically. Since its launch, cbETH has held its peg firmly, making it a good candidate for the ETH-correlated E-Mode category.
Considerations of adding cbETH to the E-Mode category
When evaluating cbETH addition to E-Mode, we look at stability and liquidity considerations. Stability, or asset volatility, is the primary consideration for understanding how well the asset can perform given the E-Mode LT setting (93%). On-chain liquidity and liquidity concentration are the primary considerations to understand the efficiency of potential E-Mode positions liquidations under the E-Mode Liquidation Penalty settings (1%).
Stability
cbETH has been around for less than six months, limiting the historical data sample. Considering the historical price range, which stabilized a couple of weeks after launch, the 93% LT of the ETH E-Mode category should accommodate the short-term volatility of cbETH.
CBETH/ETH Price History since launch. Source: Coinbase
Liquidation Penalty
cbETH liquidity is highly concentrated, so even if E-Mode is not enabled, most liquidation will occur around the 1% price slippage. Because of this, we believe that even if a significant portion of the supply will be in E-Mode (with LP set at 1%), it will not add oversized risk to the protocol. We will continue to monitor on-chain liquidity and market behavior for anomalies, changes, and supply cap utilization.
wstETH vs. cbETH
A challenging case is the borrowing and lending of wstETH against cbETH. While each of the LSDs appreciates steadily in value against ETH, we see that the price divergence between two LSDs can fluctuate more drastically. With cbETH being the second LSD introduced to this E-Mode category, we think it is important to formulate the community’s approach to LSDs in E-Mode:
Option 1 - Maximize the utilization of LSD/ETH positions. This will enable setting high LT leading to very high capital efficiency as the volatility of each LSD vs. ETH is limited. This setting still allows sophisticated traders who manage their positions consistently to open LSD/LSD positions with high capital efficiency, but they will need to be monitored consistently to be kept at adequate collateral levels.
Option 2 - Minimize liquidations for LSD/LSD positions. By accounting for the correlation and volatility of all LSDs against each other, we can ensure there will be low amounts liquidated even when large LSD/LSD unmanaged positions are opened. Optimizing for such positions (LSD/LSD) will yield a significantly lower LT setting than option 1, especially if we wish to introduce more LSDs in the near future.
We believe that enabling such a high level of capital efficiency will promote AAVE as the leading protocol for LSD utilization. We observe that LSD / ETH positions are the main use case to optimize for when setting E-Mode LT, so we recommend option 1. LSD collateral vs. LSD borrowing is technically possible because of the nature of E-Mode categories, and sophisticated traders can manage them.
As LSD markets are still early, we will observe and monitor their behavior and recommend appropriate adjustments if necessary.
Source: coinmarketcap