[ARFC] Chaos Labs Risk Stewards - Increase Supply and Borrow Caps on V3 Ethereum, Arbitrum and Gnosis - 05.14.2024

Summary

A proposal to:

  • increase the weETH supply and cap on Aave V3’s Ethereum deployment
  • increase the weETH supply and borrow caps on Aave V3’s Arbitrum deployment
  • increase the pyUSD supply and borrow caps on Aave V3’s Ethereum deployment
  • increase the GNO borrow cap on Aave V3’s Gnosis deployment

weETH (Ethereum)

Motivation

weETH has again reached full supply cap utilization, while borrow cap utilization stands at 35%.

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Supply Distribution

Supply is relatively concentrated, with the largest supplier representing 55% of the total amount supplied. This wallet is tagged as Liquid, a yield generating platform offered by Ether.fi, and is currently looping weETH and WETH. 8 of the top 10 suppliers are looping weETH and WETH, while one is looping weETH with itself and another is borrowing stablecoins against weETH and WBTC collateral.

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Overall, weETH and WETH represent 98.9% of the value borrowed against weETH, putting this market at lower risk of large-scale liquidations.

Borrow Distribution

Borrowing is relatively limited, and the largest is borrowing weETH against itself.

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Recommendation

We recommend increasing the supply cap to 200K; there is no need to increase borrow caps at this point in time.

weETH (Arbitrum)

Motivation

weETH has reached its supply and borrow caps on Arbitrum following rapid new deposits after the last cap increase.

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Supply Distribution

Supply on Arbitrum is less concentrated than on Ethereum, with the largest supplier accounting for 19.4% of the total. All of the top 10 suppliers are looping weETH with WETH, wstETH, or weETH itself, putting this market at lower risk of large-scale liquidations.

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The three ETH-correlated assets represent 96.7% of the value borrowed against weETH, again reducing the likelihood of liquidations.

Recommendation

Given user distribution and on-chain supply, we recommend doubling the supply and borrow caps.

PYUSD (Ethereum)

Motivation

PYUSD has reached 77% and 56% supply and borrow cap utilization, respectively, following a steady increase in both over the past month. Note that PYUSD cannot be used as collateral.

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Supply Distribution

Supply is dominated by three users supplying $30.5M of the $30.7M total.

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Borrow Distribution

Borrowing of PYUSD is significantly more distributed, with the largest position being $2M PYUSD borrowed against $4.7M WBTC, carrying a health score of 1.42.

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WBTC, WETH, and wstETH are the most popular collateral assets against PYUSD, representing 87.8% of the total collateral against the asset.

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These positions are at risk of liquidation in the event BTC or ETH’s price falls, though on-chain liquidity would likely support efficient liquidations.

Recommendation

Based on on-chain liquidity and user distribution, recommend increasing the supply and borrow caps.

GNO (Gnosis)

Motivation

GNO on Ethereum has reached 62% and 92% supply and borrow cap utilization, respectively, with steady growth in total borrowed. Note that GNO is in isolation mode.

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Supply Distribution

Supply is very concentrated, with the top two suppliers representing 88.9% of the total; the largest has a health score of 2.85 while the next does not borrow against its deposits.

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Given this, and the fact that it is in isolation mode, there is very little collateral at risk, even in the event of a significant drop in GNO’s price.

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Borrow Distribution

Borrows are more distributed, with the largest position representing 32% of the total amount borrowed.

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Borrows are primarily against WETH and WXDAI collateral, putting these positions at risk of liquidation if GNO’s price increases or WETH’s decreases.

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Recommendation

Given the on on-chain liquidity and user distribution, we recommend doubling the borrow cap; there is no need to increase the supply cap at this time.

Specification

Chain Asset Current Supply Cap Recommended Supply Cap Current Borrow Cap Recommended Borrow Cap
Ethereum weETH 130,000 200,000 29,500 No Change
Arbitrum weETH 16,000 32,000 1,600 3,200
Ethereum PYUSD 40,000,000 60,000,000 30,000,000 48,000,000
Gnosis GNO 60,000 No Change 2,200 4,400

Next Steps

We will move forward and implement these updates via the Risk Steward process.

Disclaimer

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

Copyright

Copyright and related rights waived via CC0

3 Likes

The transactions for this proposal have now been executed.

Hey @ChaosLabs So the 200k weETH cap was filled within minutes yet again… We could once again witness that there currently seems to exist an unlimited demand for weETH amidst the current points/airdrop farming frenzy. I do realize that this is in theory “good” for Aave, as it brings a lot of revenue.
But the pace at which this is happening is frightening. The cap has gone from 8k to 200k within 30 days, that’s a 25x increase. I can see that there was a proposal/voting a few days ago about a cap increase to 84k. We are now just a few days later 116k weETH above that proposed cap, in absolute numbers that is ~365 Million $ more already!
The weETH borrowers are already making up around 15% of the entire borrow amount on Aave and around 6% of all assets supplied.
At this magnitude, shouldn’t there be some additional limitations for new protocols/assets other than “liquidity and user risk allows it”?

I realize Etherfi is a very fast-growing protocol, but it just really emerged a few months ago in January/February. It is still not extremely battle-tested at this scale and this is exposing the entire Aave protocol to significant smart contract risks. Especially since Aave is going to add new/other LRTs as well on top of all this.
The Etherfi airdrop program ends in June and this may have impacts on incentivized DEX lp positions which may decrease available liquidity. Their withdrawal pool may run out of funds as well and lead to long withdrawal times if/when users withdraw a lot after the program. This might impact the liquidation of funds on Aave as well. Wouldn’t it make sense to wait a bit and see how all of this unfolds first, instead of maximizing the Aave revenue at all costs?
The ETH utilization is approaching the kink and soon ETH borrowing rates would potentially only be viable for points farmers as “normal” users wouldn’t pay such rates. As we speak, ETH borrow rates are already spiking to 20% levels on Aave Arbitrum and the cap is not even filled there yet. This will happen on ETH mainnet as well and as a result may lead to long term Aave users leaving for other competitors. You’d potentially end up “sacrificing” loyal long term users for short term points farmers who are likely to leave again after these airdrops end.
These points farmers are out of control right now and I think it is Aave’s responsibility to keep this in check, otherwise Aave would effectively turn into a short term “points farming casino”.
Maker went “full revenue maximization” mode with Ethena and Morpho Blue, which was heavily criticized here by many people. This behavior from Aave now is also not too different though, adding a few hundred million dollars of a non-battled-tested asset/protocol every few days now to maximize Aave revenue.

Don’t get me wrong, it’s great that Aave is so innovation-friendly and supports such new assets, that’s very commendable. But I think the pace at which this is happening is questionable.
Shouldn’t there, at the very least, be a new proposal/voting for new cap increases at this magnitude, to gauge community feedback? Maybe with different conservative/aggressive supply targets that should maximally be reached by a certain point in time?
Thanks

2 Likes

I’d also appreciate to hear opinions on this from @MarcZeller and @EzR3aL

2 Likes

Hello @PDRML, and thanks for voicing your concerns,

A bit of context:

The role of both ACI’s and Aave finance is to balance risk with protocol profitability.

Until the very recent (ETF rumours) even, the LST/wETH leverage staking trade has been the bread and butter & all weather income source for the DAO as the other source of revenue (stablecoin borrowers for long positions) was in sharp decline for the past six months, this trade & revenue was deeply hurt by morpho optimizers that were stealing borrowing revenue from us. Merit managed to kill this leech and make DAO more profitable.

Before LRTs’ farming meta, our job was simply to stimulate borrow demand to make wETH borrow cost as close (but without surpassing it) as stETH staking yield (2.9%), which we consider the index for LST revenue.

LRTs with points campaigns changed the meta as demand surpassed the staking yield due to airdrops speculators. This meta is currently justified by the very high FDV of LRTs projects.

But we all know this meta is not here to last, and there are two possible scenarios:

  1. Airdrops happen, LRT hype dies with tokens valuation, and the market deflates naturally, wETH demand reduces.

  2. Airdrops happen. Valuations stay high enough, and weETH becomes the new index to track wETH demand adapts to weETH yield yield (3.42%), allowing the DAO to modify the Slope 1 parameter to 15-20 bps lower than weETH yield, thus largely increasing DAO revenue.

If ACI & Finance SPs were “profit maxis” we would propose to change the parameters to adapt directly right now to second scenario, as weETH as collateral demand is virtually infinite right now, it’s trivial to drop back the Slope1 parameters if we scenario realize.

But we echo your concerns, and the Aave Ethos always has been not to hurt our users unnecessarily; changing the slope1 now would put all leveraged stETH/wETH users into negative yield territory, which we’re actively trying to avoid. there’s no plan to sacrifice long term users for a short term play.

We’re not MakerDAO, at Aave, we leave no ghost behind,

As I write this, we still have 300M$ of ETH demand left before reaching 2.8% wETH borrow cost; this demand can be created with 450-500M$ of new weETH inflows.

Also, it’s important to note stETH/wETH leverage staking can happen on L2s without any LRT presence, it’s actually more profitable to do them over there, and usage of L2s should be encouraged, if mainnet market profitability is overrun by LRTs, L2s can be suitable hosts for LSTs users:

image

We believe that we can increase the weETH footprint with a “stop & go” approach in Aave and remain kings of this vertical while maintaining Slope1 rates as they are right now; our bet is that short-term wETH usage above the optimal ratio will likely attract more ETH in Aave. Plain ETH deposits are the lifeblood of liquidity protocols, as they allow all these strategies to exist and scale.

About LRTs being non battle tested, you been heard loud and clear, with our due diligence and due to the fact etherFI is mostly a LST with LRT capabilities, we consider it as the lowest risk of the vertical.
It’s also currently more liquid than stETH on secondary markets

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As the current demand for weETH is very strong, we think it’s safer to limit other LRTs onboarding until the whole vertical is more mature. As Aave DAO risk should be increased only if revenue potential is worth it.

I hope that brings more light on this for you.

As your concerns are more than legitimate, we will publish today a Snapshot vote (ARFC-ADDENDUM) to query governance willingness to increase the weETH supply cap with a conservative, aggressive & option of course no raise will be represented by the “NAY” oiption.

3 Likes

Hey Marc,

After the Snapshot vote (ARFC-ADDENDUM) is approved, can the caps then be lifted via the regular Risk Stewards process? If so - wasn’t this process already voted a couple of weeks ago and approved?

Yes, the risk steward can change caps, but what’s asked of the community now is support for the continuation of raising caps.

Got it. So this vote is purely a tempeature-check to see if the community is still supportive. However, technically nothing is stopping ChaosLabs from increasing the caps even today through the risk steward process.

How many days do the Snapshosts usually remain open for votes?

1 Like

You’re correct.
3 days

[ARFC Addendum] Increase Supply and Borrow Caps for weETH

Title: [ARFC Addendum] Increase Supply and Borrow Caps for weETH

Date: 2024-05-21

Author: @ACI


Summary

This proposal asks for governance approval to raise the supply caps for weETH to accommodate growing demand. The goal is to balance risk with profitability, ensuring sustainable growth and optimized revenue.

Motivation

weETH has been consistently hitting its current supply cap, reflecting substantial market demand. Increasing the cap will provide more liquidity for users, leading to higher borrow volumes and enhanced protocol revenue.

However, some voices from the community raised concerns about the speed of growth of weETH in the aave ecosystem and would like a slowed-down approach to allow the Etherfi & LRTs ecosystem to gain maturity.

Specification

We propose governance to greenlight the Risk Stewards to raise caps according to market conditions and risk tolerance up to newly defined ceilings, with an aggressive or conservative approach.

  1. Aggressive Approach: Increase weETH caps up to 1M weETH
  2. Conservative Approach: Increase weETH caps up to 500K weETH

The implementation of new caps will be done via Risk Steward.

Disclaimer

The ACI is not presenting this ARFC on behalf of any third party and is not compensated for creating this ARFC.

Next Steps

  1. If consensus is reached on this [ARFC Addendum], escalate this proposal to the Snapshot stage with 4 options: YAE (Aggressive Option,) YAE (Conservative Option), Abstain, or NAY
  2. If the ARFC snapshot outcome is YAE, implement changes via Risk Stewards

Copyright

Copyright and related rights waived via CC0.

1 Like

To clarify - Is the snapshot already open for voting, or will only open in 3 days? Asking cause I cant see it.

ARFC ADDENDUM are special ad-hoc proposal that are lightweight and for governance quick approval, vote is already open and will last 3 days.

You can access the ARFC Addendum Snapshot here.