Overview
Recent technical developments affecting sUSD have compromised its ability to consistently maintain its peg. In line with our phased and carefully orchestrated soft deprecation strategy, we recommend the adoption of additional risk mitigation measures within the sUSD market on the Aave V3 Optimism deployment. Specifically, we propose:
- A further reduction of the supply cap
- An increase of the reserve factor to 99.9%
- The introduction of a 10% base rate
- A decrease of the slope2 to 35%
The following document offers a comprehensive overview of the asset’s current technical and market dynamics, serving as the foundation for these recommendations.
Technical Changes
Following the recent introduction of Synthetix pool 420, the Synthetix team introduced significant changes to the protocol structure:
- Progressive deprecation of solo staking and migration to protocol-managed debt
- Reduction of CF of SNX from 500% to 200% and removal of the liquidation process.
- “Debt Jubilee” or pardoning of current outstanding debt from solo staking.
While the last of this changes, the “debt jubilee”, is temporary and represent an incentive system to drive the migration to the pool 420, the other changes have a significant effect of the backing and scope of sUSD going forward.
Pool 420
Previously, sUSD was minted as a debt against SNX collateral within single staking pools; this process caused an imbalance of sUSD and excessive supply derived by free borrowing mechanisms. The introduction of Pool 420 plans to kickstart a migration of these pools to a unified protocol-managed pool. This pool will allow users to deposit SNX, and this collateral will be used to mint sUSD and utilize it within defi strategies such as Curve pools and farm funding to accrue yield. The accrued yield will then be distributed pro-rata to the SNX stakers within the pool itself.
Currently, 147M SNX were migrated to the new pool, representing a collateral value of $92M that has been used to mint roughly 7.1M sUSD of protocol-managed debt.
As part of the migration to protocol-managed debt, a significant structural adjustment is introduced: the SNX collateral factor within the unified pool is being reduced from 500% to 200%. Additionally, the removal of the liquidation mechanism necessitates that the protocol assumes full responsibility for managing this pool. This transition is predicated on the assumption that such protocol-led management remains optimal and does not introduce risks of undercollateralization.
Debt Jubilee
As an incentive to users currently borrowing sUSD within solo-staking pools, Synthetix offers to forgive their sUSD debt. This debt will be gradually accrued by the protocol’s treasury over 12 months since the initial debt migration. While this incentive is not expected to be permanent, it has attracted a total of 53M sUSD of debt migrated since its start, of which 5M sUSD has been forgiven and accrued by Synthetix treasury.
If a users wishes to exit the pool prior to the complete forgiveness of its debt it will be required to pay the outstanding debt balance in addition to an early withdrawal penalty which will start at 100% on the first day a staker enters the pool and linearly reduce to 50% on the last day of the 12 month lock.
Price deviation
Following the introduction of the debt jubilee, sUSD suffered a severe drop in price, deviating significantly from its 1$ peg until reaching a recent low of $0.83. This price deviation has been caused by a combination of factors, such as a loss of user confidence in the new protocol mechanics and a lack of demand, especially in the context of cheap debt repayment and a lack of liquidations.
Recommendation
Over the past few months, significant adjustments have been made to the risk parameters of sUSD in response to the observed peg instability and inefficient market mechanisms, which have fully minimized theoretical risk at the protocol level:
On Jan 17th, the supply cap was reduced from 22M to 10M and borrowing was disabled (borrow cap set to 0) through the risk stewards.
On Jan 24th, sUSD’s LTV was set to 0 and stablecoin E-mode LT was lowered from 93% to 87%.
On March 29th, sUSD’s supply cap was further reduced to 3.8M.
As of today, the reserve sits at a meager 2M supplied and 1.66M borrowed, down from 12M supplied and 5M borrowed just 90 days ago.
This indicates a successful soft deprecation of the asset thus far, coupled with minimal outstanding collateral at risk given the current distribution of collateralized debt positions.
As such, in an effort to further deprecate the reserve safely, we recommend increasing the asset’s Reserve Factor to 99.9%, instituting a 10% base rate, decreasing the slope2 to 35% and reducing the supply cap to 2M sUSD to align with the recent drop in supply and borrow demand. The supply cap reduction will be performed through the risk steward process.
Specification
sUSD Aave V3 Optimism
| Parameter | Current Value | Recommended Value |
|---|---|---|
| Reserve Factor | 20% | 99.9% |
| Supply Cap | 3,800,000 | 2,000,000 |
| Base Rate | 0% | 10% |
| Slope2 | 50% | 35% |
Disclaimer
Chaos Labs has not been compensated by any third party for publishing this ARFC.
Copyright
Copyright and related rights waived via CC0