[ARFC] Activate LUSD as Collateral on Aave V3 ETH Pool

[MarcZeller]

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title: [ARFC] Activate LUSD as Collateral on Aave V3 ETH Pool
author: Marc Zeller @marczeller - Aave Chan Initiative
date: 2023-07-31

Summary

This ARFC proposes to activate LUSD as a collateral asset on the Aave V3 ETH pool. The proposed risk parameters for LUSD will mirror those currently in place for USDC on the same pool.

Motivation

LUSD is a decentralized stablecoin minted by users of the Liquity Protocol. It has demonstrated its resilience and maintained a stable peg, even in volatile market conditions. By adding LUSD as a collateral asset on the Aave V3 ETH pool, we can offer our users more options for their DeFi activities. Furthermore, the integration of LUSD could potentially synergize with the GHO, enhancing liquidity and further reinforcing the stability of the peg.

Specification

The proposed risk parameters for LUSD on the Aave V3 ETH pool are as follows:

Parameter	Value
Loan-to-Value (LTV)	77%
Liquidation Threshold (LT)	80%
Liquidation Penalty	4.5%

These parameters are identical to those currently in place for USDC on the Aave V3 ETH pool.

Disclaimer

This proposal is part of the Skyward program, the ACI has not been compensated by any third-party to present this ARFC.
At the time of writing, the author does not hold LQTY tokens but owns some LUSD.

Next Steps

1. Gather community feedback and reach consensus on this ARFC.
2. If consensus is reached, escalate this ARFC to the Snapshot stage for voting.
3. If the Snapshot outcome is YAE, escalate to AIP for final approval and implementation.

Copyright

Copyright and related rights waived via CC0.

[0xkeyrock.eth]

We support the listing of LUSD as collateral.

[Tor_GAINS]

LUSD has proven its resilience over the years. As an AAVE community member, I support this proposal.

[TokenBrice]

Hello there,

TokenBrice from the Liquity team.

We are thrilled to see this ARFC being submitted, and I’ll be happy to answer any community questions regarding LUSD.

I think the parametrization is appropriate, especially considering the relatively conservative cap currently enforced on LUSD (6M max supply = ~2% of the total supply of LUSD, currently around 300M).

Besides, with GHO now live, I agree with the motivations highlighted by @MarcZeller: adding LUSD as collateral on Aave would be a mutually beneficial venture, as it will help further diversify GHO’s backing with a stable and sturdy asset.

Thanks to Marc & ACI for submitting this ARFC, looking forward to hearing the community’s feedback.

[ChaosLabs]

Overview

Chaos Labs supports enabling LUSD as collateral on Aave v3 Ethereum in Isolation Mode based on the asset’s historical stability and its potential to diversify the range of stablecoins available for use as collateral on Aave, further empowering the use of decentralized stablecoins.

Following is our analysis and risk parameter recommendations.

Analysis

Liquidity and Market Cap

When analyzing market cap and trading volumes of assets for listing, we look at data from the past 180 days. The average market cap of LUSD over the past 180 days was ~$270, and the average daily trading volume was ~$6.2M (CeFi & DeFi).

Historic Stability

LUSD has demonstrated remarkable stability, weathering various market fluctuations and black swan events. Its consistent performance showcases its reliability and suitability for being used as collateral on the Aave Protocol.

Current Risk Parameters

While acknowledging the inherent risks associated with adding any new asset as collateral, the potential risks associated with LUSD are mitigated through the prudent implementation of supply and borrow caps. These caps will ensure that the exposure to the asset remains limited and controllable, preventing any undue impact on the stability and security of the Aave Protocol.

The existing Supply and Borrow caps exhibit a risk-averse stance, aligning appropriately with the current on-chain liquidity. We firmly believe that this cautious approach is well-suited for an asset being considered to be enabled as collateral on the platform for the first time.

Regarding the specific parameters for the Reserve Factor, Liquidation Protocol Fee, and Interest Rate curves we suggest keeping the current parameters as they are configured.

We will continue to closely monitor user behavior and track the asset’s performance as collateral. Based on real-world data and the asset’s evolving use case, we will proactively adjust these parameters to ensure optimal risk management and continued platform security.

Debt Ceiling

Following Chaos Labs’ Isolation Mode Methodology, we recommend an initial debt ceiling of $5.4M. Under the methodology for Isolation Mode, we consider two levels of probabilities for extreme price drops - Medium-High and High. We estimate the probability of an extreme price drop for LUSD as Medium-High. Given this debt ceiling, we do not identify a profitable attack vector under the current liquidity levels.

Liquidation Penalty

Given the concentrated liquidity of LUSD on Ethereum we recommend a 5% Liquidation Penalty.

Recommendations

We support the recommendations in the post for the Loan-to-Value and Liquidation Threshold.

Following the above analysis, we recommend the following parameters if the community decides to enable LUSD as collateral:

Parameter	Value
Collateral Enabled	Yes
Isolation Mode	Yes
Debt Ceiling	$5.4M
Loan-to-Value (LTV)	80.00%
Liquidation Threshold (LT)	77.00%
Liquidation Penalty	5.00%

[Gauntlet]

Gauntlet supports enabling LUSD as collateral with the parameters proposed by ACI. Liquity allows for 1 LUSD to be redeemed for $1 of ETH at all times as a soft peg, in a mechanism that soft liquidates the loans with the lowest collateral ratios on Liquity.

• Loans on Liquity have a minimum collateral factor of 110%, which indicates at least a 10% buffer between the LUSD minted and the ETH that backs it.
• Because ETH is the asset that backs LUSD, very sudden ETH price drops may also cause LUSD to deviate from its $1 peg.

LUSD price

LUSD supply vs supply cap on v3 Ethereum