Gauntlet Recommendations
Summary
At this time and with assumptions discussed below, Gauntlets supports:
- The growth plan for the bucket facilitator capacity values (apart from the initial bucket capacity)
- The initial Borrow Rate (this is highly sensitive to borrower elasticity, which needs to be monitored closely)
- The stkAAVE discount rate model
However, Gauntlet recommends that DEX stable pools increase the target balanced DEX concentration by 5%-25% at each bucket capacity level and to initialize with a bucket size of the previously suggested 50M. Understanding how much liquidity will be introduced to DEXs shortly after launch could allow for faster bucket growth. If the DEX liquidity in the first 10M GHO issued is proportionately added to DEXs, we could potentially propose raising the bucket capacity sooner than 1 month, but before that data exists, the growth and risk trade-off would support a smaller initial bucket capacity. In addition, Gauntlet will give specific stability ranges that should be targeted given market risk considerations.All of the recommendations below can change if new details about the GSM are released or the growth plan changes.
Key Risk Factors
There are several risks Gauntlet would like to highlight for the community, that will need to be proactively managed
- Low liquidity and usage: If GHO < $1 and lending pool liquidity for assets used to mint GHO is low (i.e. utilization for those assets is high), then GHO repeg can slow or be difficult, especially for the set of GHO minters that are looking to completely close their position.
- Emode compounding supply: Usage of emode minting GHO to restore the peg if GHO > $1 could lead to premature GHO supply explosion, especially when DEX size is not sufficient.
- GSM design uncertainty: Loss of liquidity in the GHO PSM, or devaluation of the assets in the GHO PSM (as seen during the USDC price deviation) can lead to a significant price deviation in GHO. We will discuss our recommendations with specific assumptions around the GSM below.
- Hard-coded 1 price within Aave V3: This could lead to increased liquidations on the Aave V3 protocol as the market and oracle price of GHO could follow USDC (see DAI during March 11-13). These liquidations would be incorrect as well as adverse (does not help the protocol prevent insolvencies).
From a risk perspective, Gauntlet recommends that DEX stable pools increase the target balanced DEX concentration by 10% at each bucket level. The initial analysis notes that usually, 15-30% of stablecoin supply is usually in DEX. However, GHO has many novel components. The fixed borrow fee, the interplay between the GHO markets and the regular lending markets (given that Aave v3 Ethereum will be the first facilitator), and the fact that GHO is a completely new market, increase the risk of extreme GHO price deviation and GHO manipulation without sufficient DEX liquidity.
The community should decide at what speed is appropriate to scale GHO and determine the necessary bucket sizes and borrow rates.
We’d also like to call to attention some key risk factors - particularly with regards to GHO liquidity. The community should be aware of these risks and discuss, if necessary, how to mitigate these risks.
- Aave v3 Ethereum as the facilitator.
- The interplay between GHO minting and the lending markets. Collateralized assets used to mint GHO will flow to the lending pool. Suppose GHO is trading < $1, then GHO minters can buy GHO externally to repay on the Aave v3 lending markets, helping to repeg. For those repayers that are looking to close their position as well and redeem their collateral through the facilitator, if there is insufficient liquidity on the lending markets for this collateral (i.e. the collateral has high utilization), then they may not be able to repay the GHO. An example of this is when a GHO minter needs to flashloan other assets to purchase GHO externally and needs their collateral to close out the flash loan. This could hurt the repegging.
- Because of this interplay, fixed and static fee (that requires governance to change) could lead to unmitigated GHO minting → dump when GHO is abnormally < $1. If the peg restoration mechanism is failing, then sophisticated traders can mint up to the remaining bucket capacity at the fixed rate and market-sell the minted GHO to further depress GHO prices. Until the redemption mechanism recovers and liquidity is restored we can expect GHO price to continue to fall (as seen with USDC). The trader can then buy back the GHO at a much lower price to close their position.
- Usage of emode minting GHO to restore the peg if GHO > $1 could lead to a premature GHO supply explosion, especially if DEX liquidity has not caught up. As mentioned in the initial analysis by Aave Companies, the maximum supply of GHO can be increased to bring GHO back down to par. The proposed emode implementation, at the current LT of 97.5%, enables less capitalized users at ~30x leverage to affect peg restoration greatly. The end result is that the pool will be rebalanced at the same TVL, but the global GHO supply will have expanded, decreasing the DEX GHO / GHO supply ratio. Without a GSM, GHO at this increased supply may be more susceptible to price manipulation.
- Usage of idle proposed GSM liquidity. As the initial review has indicated, a majority of DAI is minted through the Maker PSM. Recently, Maker governance has voted to onboard $100M USDC into Yearn. As such, idle liquidity in the proposed PSM for GHO will need to be managed carefully and prudently, given that yield strategies have associated inherent risks (smart contract, market, etc). Loss of liquidity in the PSM, or devaluation of the assets in the PSM (as seen during the USDC price deviation) can lead to a significant price deviation in GHO.
The above is assuming GHO is only released on mainnet Ethereum. Proposed GHO deployment on L2 could introduce further risks, which Gauntlet is continuing to study.
Assumptions
The initial stability module will resemble the current Maker Peg Stability Module (PSM). This implies that the GSM enables GHO-USDC swaps at a 1:1 fixed ratio and backs minted GHO with deposited USDC.
The initial DEX liquidity will be in a pool with this specific parameterization: Amplification parameter A = 200, fees = 0.04%, pool is 50/50 GHO and 3pool.
We will use the bucket capacities put forth in the initial post as a baseline for our DEX liquidity recommendations. Note that this methodology could change with bucket capacity changes, but we agree with the growth plan at this current moment in time.
Assumptions: Current GHO parameterization
Risk Appetite: Trade-offs and target stability ranges
We will use this graph built from the assumptions above to guide the conversation about risk. The graph shows the you could trade through around 54% of the pool size and see the price change by 1%. We will use the expected price movement against trade size to bound the desired price deviation of GHO. In this case, we will assume that during a potential price deviation scenario, up to 10% of the circulating supply of GHO will be sold (this value is chosen because on March 10th, approximately 3.4B USDC was trade of the 30B circulating supply on Ethereum). This allows us to calculate the liquidity under worst case scenarios to be calculated; for example, the DEX liquidity target for a price range of [0.95, 1.05] will be 6.25M = 50M*0.1/0.8, where 50M is the max supply, and 0.8 is the intersection on the graph with 0.95.
| GHO price target [0.999, 1.001]* | [0.995, 1.005] | [0.99, 1.01] | [0.95, 1.05] | |
|---|---|---|---|---|
| DEX liquidity target (at launch, capacity = min(50M, 25% borrows)) | ~all GHO issued | 15.7M GHO | 9.4M GHO | 6.25M GHO |
| DEX liquidity target (after 1 month, capacity = min(100M, 25% borrows)) | ~all GHO issued | 30M GHO | 18.8M GHO | 12.5M GHO |
| DEX liquidity target (when DEX liquidity pools reach previous target in cell above, capacity = 250M) | ~all GHO issued | 70M GHO | 47M GHO | 31.3M GHO |
*Note: this seems to imply that the price distribution will be centered around 1, but that assumption might not hold.
We recommend the [0.995, 1.005] target range, which would require these levels of DEX liquidity: 15.7M GHO at launch, 30M GHO after 1 month, and 70M GHO to facilitate a capacity size of 250M.