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% |