[ARFC] Chaos Labs Risk Parameter Updates - wstETH liquid e-modes on Arbitrum, Base, Scroll - 11.01.24

Summary

With the release of Aave v3.2 and the introduction of Liquid E-Modes, we now have the capability to assign multiple E-Modes to a single asset. This proposal introduces a wstETH/WETH E-Mode on the Arbitrum, Base, and Scroll chains.

Motivation

Prior to Aave v3.2, E-Mode configurations were constrained to the least liquid and stable asset within each E-Mode pool, limiting capital efficiency. Liquid E-Modes now enable more tailored E-Mode configurations, allowing for optimization across different asset pairs. Given the reliable peg stability and liquidity of wstETH, this recommendation proposes aligning wstETH/WETH E-Mode parameters on Arbitrum, Base, and Scroll with those of the Ethereum Lido instance.

Liquidity

On each chain, we observe the following liquidity characteristics:

  • Base: On Base, liquidity is predominantly concentrated on Aerodrome Slipstream, with a TVL of approximately $28 million. Over the past month, liquidity on Base has grown steadily, reflecting increased interest in wstETH and WETH trading pairs. This growth has culminated in approximately 11,700 WETH in buy-side liquidity.

  • Arbitrum: In contrast to Base, liquidity on Arbitrum is more dispersed across multiple platforms, with the largest wstETH/WETH liquidity pool on Uniswap V3 holding a TVL of $3 million. Total buy-side liquidity on Arbitrum currently stands at around 4,100 WETH, providing sufficient liquidity for E-Mode configurations, although recent trends indicate a slight reduction in available liquidity.

  • Scroll: Liquidity on Scroll is split between Nuri and Ambient, with each platform holding roughly $3 million in TVL. Buy-side liquidity across the Scroll network totals around 2,100 WETH. Liquidity on Scroll recently rebounded after a temporary drop following the end of the Scroll points program.

Peg Stability

Price deviations can cause problems like arbitrage exploitation, where, given the underlying liquidation threshold, users take advantage of price differences between the protocol’s fundamental valuation of an asset and its market price, potentially destabilizing liquidity. This can lead to WETH debt accrual and thus, in tandem with WETH collateral liquidations and withdrawals due to the underwriting of temporary mispriced debt, lead to interest rate and utilization spikes, with LST/LRT-collateralized e-mode LTVs gradually (net) increasing while WETH collateralized stablecoin debt positions risk unperformed liquidations due to such utilization rates.

These deviations typically arise during periods of market stress. In such scenarios, deviations are driven by complex factors, including investor de-risking from volatile assets, liquidation cascades triggered by non-correlated positions such as stablecoin borrows against WETH, and, in rare cases, slashing events that erode confidence in an asset. The speed of reversion is generally contingent on the market priced implied duration risk associated with such a WETH-correlated asset, which can be dynamic dictated by exit queue considerations, as well as the game-theoretic value given by the fundamental robustness and on-chain liquidity of the asset itself.

For this reason, to gauge the resilience of wstETH’s peg to ETH across different chains, given by the available liquidity and leverage on the chain, we analyze price behavior during the market drop that occurred on August 5, 2024, during which WETH suffered a 21% daily drop, with the rest of the market following suit and LST/LRT assets showing significant deviations. Despite that, wstETH demonstrated strong reversion characteristics across Base, Arbitrum, and Scroll. This observation indicates a high degree of stability that supports the proposed E-Mode parameters.

  • Base: On Base, wstETH dropped to a minimum of 1.1490 WETH, representing a 2.1% depeg. Despite this dip, the asset quickly returned to its peg, demonstrating resilience and a tendency toward mean reversion under stress.

  • Arbitrum: On Arbitrum, wstETH experienced a smaller depeg of 1.66%, reaching a low of 1.1550 WETH. Although this recovery was slightly slower than on Base, wstETH still demonstrated consistent mean reversion and stability.

  • Scroll: Scroll displayed the most stable performance, with wstETH depegging by only 0.56%, reaching a low of 1.169 WETH. While the recovery was not as rapid as on Base, it still represented a strong return to peg, underscoring WSTETH’s reliability.

LT and LTV

The combination of robust liquidity, strong peg stability, and the inherent resilience of wstETH ensures that aligning LTV and LT parameters for the wstETH/WETH E-Mode on Arbitrum, Base, and Scroll to the one on Lido instance is both feasible and prudent. This is because the ETH-correlated E-Mode configuration is constrained by the least liquid and least stable assets within the pool, limiting capital efficiency across the board. However, with these updated configurations, we can adopt parameters that better reflect the liquidity and stability of wstETH, allowing for higher capital efficiency in isolated E-Modes.

Hence, we recommend setting the LTV at 93.5% and the LT at 95.5%. By enabling a high level of leverage, these parameters are also expected to increase demand for WETH across the chains.

Collateral and Borrowable

To prevent same-asset looping, which could undermine the intended use of liquidity incentives and lead to unintended utilization, we recommend configuring wstETH as collateral and WETH as borrowable in the proposed E-Mode. This structure aligns with the approach detailed in this post, which advocates for selective collateral and borrowing configurations to maintain market efficiency.

Specification

Based on the considerations outlined above, we recommend implementing the following E-Mode configurations for the wstETH/WETH pair on the Base, Arbitrum, and Scroll networks.

wstETH/ WETH (Base)

Parameter Value Value
Asset wstETH WETH
Collateral Yes No
Borrowable No Yes
Max LTV 93.5% 93.5%
Liquidation Threshold 95.5% 95.5%
Liquidation Penalty 1.00% 1.00%

wstETH/ WETH (Arbitrum)

Parameter Value Value
Asset wstETH WETH
Collateral Yes No
Borrowable No Yes
Max LTV 93.5% 93.5%
Liquidation Threshold 95.5% 95.5%
Liquidation Penalty 1.00% 1.00%

wstETH/ WETH (Scroll)

Parameter Value Value
Asset wstETH WETH
Collateral Yes No
Borrowable No Yes
Max LTV 93.5% 93.5%
Liquidation Threshold 95.5% 95.5%
Liquidation Penalty 1.00% 1.00%

Next Steps

  1. Direct to AIP process.

Disclaimer

Chaos Labs has not been compensated by any third party for publishing this ARFC.

Copyright

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