[ARFC] Chaos Labs Risk Parameter Updates - wstETH / WETH E-mode Parameters for Lido Market - 10/20/24

[ChaosLabs]

Summary

With the introduction of Aave v3.2 and Liquid E-Modes, it is now possible to assign multiple E-Modes to a single asset. In this recommendation, we evaluate the E-Mode parameters for the wstETH/WETH category in the Ethereum Lido market and propose changes following Chaos Labs’ methodologies.

Motivation

While factoring in on-chain liquidity, historical volatility, and daily price movements supports the current LTV, LT, and Liquidation Bonus settings for wstETH and WETH in the Lido market, we believe that allowing both assets to be borrowable and used as collateral conflicts with the market’s core purpose.

The Lido market aims to maximize leverage on LST yields in an efficient and secure environment. Allowing both wstETH and WETH to be borrowable and used as collateral doesn’t add significant value and limits the market’s potential for new asset listings.

Usage

The demand to use WETH as collateral to borrow LST assets is minimal, even in the Ethereum main market where caps allow it. In the Ethereum main market, this represents less than 1.5% of total assets borrowed against WETH.

Looping

Currently, usage of WETH collateral and wstETH borrows on the Lido market is primarily driven by users looping to farm market incentives, which diminishes the effectiveness of those incentives and reduces the supply available for users with genuine yield-leveraging goals.

Top wstETH Borrowers in Lido market

With the introduction of the ezETH/wstETH liquid E-mode category, increasing the borrow cap of wstETH would enable users to leverage ezETH yield by borrowing wstETH against ezETH collateral. However, unless WETH is made non-collateral and wstETH non-borrowable, this may drive more users to loop to farm wstETH supply incentives, which this recommendation aims to prevent.

Specification

wstETH / WETH

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%	1%

Next Steps

1. Direct to AIP process.

Disclaimer

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

Copyright

Copyright and related rights waived via CC0

[LlamaRisk]

Summary

LlamaRisk supports this proposal, which addresses two key issues:

1. wstETH Borrow Cap Increase: The upcoming introduction of ezETH collateral on Aave V3 Lido requires raising the wstETH borrow cap from its current 100 wstETH limit, which is fully utilized.
2. Use Case Restriction: The current cap utilization is due to users leveraging the wstETH/wstETH strategy for awstETH rewards. The proposal aims to restrict the WETH/wstETH use-case while increasing the borrow cap.

These changes will prevent the expanded borrowing capacity from being consumed by existing reward-farming strategies, reserving it for the intended ezETH/wstETH leveraged-looping strategy.

Current Usage

The wstETH/wstETH and WETH/WETH use cases are currently employed to farm liquidity incentives. This strategy is profitable because the borrowing rate is lower than the supply rate plus the liquidity incentive. The 100 wstETH borrow cap limits these extractive use cases and the more profitable wstETH/WETH looping use case for WETH.

Source: wstETH borrow usage on the Aave V3 Lido instance, October 21st, 2024

Current WETH/WETH e-mode borrows amount to $25.4m, while wstETH/wstETH e-mode borrows amount to $284.83m.

Proposal Effect

Allowing wstETH as collateral only and WETH as borrowable only in the wstETH-WETH E-mode will prevent farming of incentives on both wstETH and WETH deposits. The increase in the wstETH borrow cap will be dedicated solely to the future ezETH/wstETH leveraged-looping use-case.

Disclaimer

This review was independently prepared by LlamaRisk, a community-led non-profit decentralized organization funded in part by the Aave DAO. LlamaRisk is not directly affiliated with the protocol(s) reviewed in this assessment and did not receive any compensation from the protocol(s) or their affiliated entities for this work.

The information provided should not be construed as legal, financial, tax, or professional advice.

[x2daniel]

In the wstETH-WETH E-mode, if the WETH cannot be collateral any longer (not as today with WETH considered as a collateral with a max LTV=0), does it mean that the existing WETH-WETH loopers (“legacy”) will be liquidated when this AIP is implemented ?