[ARFC] Offboard DAI from V3 eMode

Title: [ARFC] Offboard DAI from V3 eMode
Author: @mcsquared Allez Labs
Date: 2024-05-10

Summary

Remove DAI from Aave V3 stablecoin eMode.

Motivation

The Aave DAO has voted to reduce the LTV and LT of DAI across all active markets iteratively in a response to governance unpredictability and the perceived risks MakerDAO has undertaken with DAI’s collateral. The current plan as we understand it is to offboard DAI as a collateral asset. As such this temp check gauges the DAOs appetite to keep DAI on as an eMode asset on the V3 Arbitrum, Avalanche, Optimism, and Polygon markets, or to remove it.

Specification

Remove DAI from stablecoin eMode across all markets where it is active.

Market Asset Current eMode Category Proposed eMode Category
Arbitrum DAI 1 (stablecoins) 0 (no eMode)
Avalanche DAI 1 (stablecoins) 0 (no eMode)
Optimism DAI 1 (stablecoins) 0 (no eMode)
Polygon DAI 1 (stablecoins) 0 (no eMode)

Analysis

Currently DAI is listed as a stablecoin eMode asset on all V3 markets which have stablecoin eMode enabled - Arbitrum, Optimism, Polygon, Avalanche. Its use is moderate as both an eMode collateral asset and as eMode debt, representing less than 1% of value supplied and borrowed on V3 Arbitrum, Avalanche, and Optimism and less than 2% on Polygon V3 Markets.

Despite this relatively small scale, stablecoin eMode poses a significant risk vector for the protocol. Historical events, such as the sharp, non-correlated price volatility witnessed during the Silicon Valley Bank (SVB) collapse in March 2023, have led to insolvencies within the protocol. Infact, the majority of the bad debt on V3, amounting to approximately $360,000, arose from the USDC depegging event, primarily from eMode positions.

While currently, the risk of insolvencies is low, keeping DAI as an eMode asset will continue to allow high leverage DAI positions on the protocol. As there is concern with high LT/LTVs on non-eMode positions, we believe it is most consistent to remove DAI from eMode to control risk.

Market Asset Supplied Borrowed eMode Collateral* eMode Borrowed* Annualized revenue est from DAI eMode debt* Collateral available for liquidated
Arbitrum DAI 10.9m 9.0m 20k 272k $7.0k 9k
Avalanche DAI 4.4m 3.6m 121k 173k $4.5k 57k
Optimism DAI 4.3m 3.5m 100k 40k $1.3k 60k
Polygon DAI 18.0m 14.0m 807k 2.0m $56.0k 205k

*eMode usage numbers here are found by looking at positions that have eMode enabled, are supplying an eMode asset, and have an active eMode borrow. In short, these are the positions which are using eMode. Annualized revenue estimated with current RF and average 30 day (variable) borrow rates. As of May 9th.

Impact of DAI eMode removal

Removing DAI from eMode will materially impact the health factor of many eMode accounts due to the relatively large discrepancy between the eMode LT and non-eMode LT (95% to 77%). In the above table, we see estimated liquidations may reach $330k if implemented today. However, in the past, active borrowers (as many eMode stablecoin users are) have responded to governance changes that may impact their position, and we anticipate many would close or change their positions in anticipation of any eMode governance changes.

Market DAI eMode LT DAI LT (post V3 AIP 87)
Arbitrum 95% 77%
Avalanche 95% 77%
Optimism 95% 77%
Polygon 95% 77%

Notable impacted accounts:

User DAI as eMode Collateral Market
0x6244 270k Polygon V3
0x5b8e 122k Polygon V3
0x0fe2 92k Polygon V3

Alternative:

Alternatively to removing DAI from eMode the DAO can consider decreasing the stablecoin eMode category LT/LTV. While this would mitigate some of the risk of a DAI depeg, this would remove the competitiveness of Aave V3’s eMode category as a whole. We do not recommend this.

Recommendation:

At this time, we recommend removing DAI from eMode despite it only representing a modest portion of total DAI borrowed from and used as collateral in the protocol. We suggest pausing any further DAI LT reductions on markets with stablecoin eMode since this further increases potential liquidations from such an eMode change. Since this process cannot be done in phases like previous large LT reductions, we recommend communicating through relevant channels the impact such a change will have, and monitoring potential liquidations, while only proposing an AIP for this change once the value liquidated is deemed minimized.

Disclaimers

None

Next Steps

  • Gather community feedback
  • Snapshot

Copyright: Copyright and related rights waived via CC0.

2 Likes

Hello,

Thanks for creating this proposal, Moved it to ARFC status as there’s no need to do a TEMP CHECK for an evolution of risk parameters of an already onboarded asset.

I think there’s a limitation to leaving emode in Aave V3, but it might have been fixed with Aave 3.1. @bgdlabs will know best.

Pinging as well risk teams on the topic: @ChaosLabs & @LlamaRisk

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Summary

This proposal to remove DAI from eMode on Arbitrum, Avalanche, Optimism, and Polygon aligns with the DAO’s decision to reduce the loan-to-value (LTV) ratios for DAI and sDAI on Aave. We note that the main area of concern is the recent exposure of DAI to Ethena’s USDe and Maker’s evolving roadmap, with new details (NewStable & PureDai tokens) announced this week.

Based on our extensive risk assessment of USDe (general assessment | Aave specific considerations), we concluded that Ethena does not currently pose a significant risk to DAI backing. DAI exposure to USDe is marginal, 4% at the time of writing, and up to 12% if the D3M loan reaches the approved debt ceiling of 1b. USDe liquidity provision, mainly on Curve and Uniswap and also supplemented by the recent Bybit listing, appears to be sufficient. We also note a good diversification of DAI’s over-collateralized portfolio.

LlamaRisk believe this change is not immediately required, with the potential for adverse effects on a few large accounts, as noted by @mcsquared. Should the DAO decide to proceed, allowing sufficient time for depositors at risk of liquidation to take appropriate actions is recommended to ensure a smooth transition and minimize user impact.

Risk considerations

DAI exposure to Ethena Protocol

DAI gains exposure to Ethena’s hedged perpetual yield through the “DIRECT-SPARK-MORPHO-DAI” loan facility. By minting DAI to a Spark DAI MetaMorpho vault, Maker supports the supply of DAI to multiple markets that can be borrowed against with USDe/sUSDe collateral.

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Source: Makerburn.com, May 16th, 2024

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Source: Makerburn.com, May 16th, 2024

Upcoming Developments in the Maker ecosystem

In line with the ever-evolving Maker endgame plan, it is important to follow the latest developments and roadmap for DAI, namely:

Vision of DAI’s Future

The latest perspectives on the future of DAI can be found in this forum post. The Maker community’s vision for DAI involves creating two distinct stablecoins to address the Stablecoin Trilemma: NewStable, focused on utility and scale, and PureDai, emphasizing pure decentralization. NewStable will integrate RWAs and TradFi, while PureDai will use only decentralized collateral. The transition will be gradual, with DAI initially functioning as usual and eventually serving as a backend for NewStable. MKR will remain linked to MakerDAO, allowing holders to upgrade to a new governance token.

The ongoing monitoring of these changes and how they may impact the Aave ecosystem is very important.

Discussion on additional exposure to USDe

Maker is considering gaining additional exposure to USDe via their Andromeda vault, involving:

  • TACO Foundation & TACO & SUBS, LLC: Cayman Islands entities to facilitate real-world activity
  • BlockTower Capital: Manages assets per Subsidiary’s guidelines
  • Ankura Trust: Paying agent for fees, assists with deployment/returns
  • Coinbase: Exchange & custody platform (Coinbase Prime Web3 Wallet)

We plan on posting a detailed analysis of the implications of this change should Maker decide to proceed with this proposal.

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Brief Update on Maker’s RWA Portfolio

We prepared the brief below for Aave DAO’s consideration. We are actively monitoring changes in DAI collateral and are determined to provide timely updates as the situation evolves.

Summary

In September 2023, we examined Maker’s exposure to real-world assets (RWA), most notably exposure to short-term bonds, Coinbase Custody, and private credit. While the macro environment has changed since then, with on-chain yields now exceeding Treasury bill yields, monitoring these RWA positions backing DAI remains important. This brief aims to provide an update on the Monetalis arrangements and review the proposed structure for onboarding additional USDe.

DAI Collateral and Revenue Generation

Recent data from Makerburn indicates that DAI allocated to Morpho and Spark through the D3M facility is now generating substantial yields for Maker. These on-chain revenues have overshadowed RWA-yielding strategies, leading to a reduced focus on such approaches. Notably, the Monetalis Clydesdale vault, once a top revenue earner, has now fallen out of the top five contributors.

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Source: Makerburn, May 22nd, 2024

Review of Monetalis Arrangements

In light of the recent findings regarding Monetalis’s non-performance, the notes herein aim to examine the role of Monetalis in the RWA structure devised by MakerDAO. The Coinbase Custody Legal Assessment discloses the reporting agreement between JAMES ASSET (PTC) LIMITED (“JAL”) and MONETALIS SERVICES LIMITED (“Monetalis”).

Incorporated under British Virgin Islands laws, Monetalis has agreed to act as the Reporting Agent. The firm was tasked with delivering specific reporting services pertinent to the management of trust assets, notably concerning the intended reallocation of 500 million USDC from the Protocol Stability Module (PSM) to Coinbase Custody, as outlined in MIP65. It is critical to note that JAMES ASSET LIMITED manages additional assets from other Maker’s transactions in distinct trusts—specifically, assets related to MIP65 are segregated into two trusts: James Asset Trust 1 (JAT 1) and James Asset Trust 2 (JAT 2).

Furthermore, Monetalis’s responsibilities include acquiring and disseminating information concerning the Trust Assets to MakerDAO, as detailed in Schedule 1 of the agreement.

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Under the terms of this agreement, any non-performance is governed by the provisions outlined in Section 9, “REMEDIES AND WAIVERS.” This section clearly articulates that neither the failure nor delay in exercising any right or remedy by any party constitutes a waiver thereof, nor does it preclude any further or subsequent exercise of such rights or other remedies.

Our analysis suggests that JAL retains the right to enforce Monetalis’ obligations under the agreement and to seek damages for any delayed performance. JAL is authorized to terminate Monetalis’ engagement with at least one month’s written notice. Additionally, any legal disputes emanating from this agreement are to be exclusively adjudicated in the courts of the British Virgin Islands.

Monetalis’ operational role in the fund’s distribution primarily involves transferring USDC from the Protocol Stability Module (PSM) to a JAL account at Coinbase by executing a smart contract’s push function. Each transfer requires collaborative action from both JAL’s director and the Administrator in alignment with the relevant resolutions passed by MakerDAO.

The custodianship and management of funds are securely divided between two separate entities—JAL and Coinbase—neither of which has any affiliationto Monetalis. Monetalis is primarily charged with post-transaction reporting, positioning it in a role with a comparatively lower risk profile. There is no immediate risk of Monetalis performing unauthorized transactions or becoming insolvent, jeopardizing the counterpart’s funds.

Notwithstanding, Monetalis remains liable for the accuracy of the information it provides and for fulfilling its contractual duties. Based on our review of publicly available resources, we find no immediate risk to the assets if the custodianship arrangement with Coinbase has not been deprecated.

The recent scrutiny from the community has compelled Monetalis to answer questions regarding their inconsistent actions. Vigilant oversight by multiple stakeholders is undeniably beneficial; however, these events highlight the necessity for the community to consider implementing a process wherein an independent third-party professional audits the role of the arranger.

Proposal for Purchase of USDe via Existing Andromeda Facility

While the above-reviewed arrangements are pertinent to a functional collateral setup (i.e. Monetals Clydesdale RWA007-A), the following examines a proposal made earlier this year for the purchase of USDe/sUSDe via the existing RWA-015 Andromeda vault. It is important to note that this proposal has yet to be voted on.

Recap of Maker’s Legal Structure for USDe Purchases

The USDe purchase is envisioned through DAI deployments from the Andromeda Vault (utilized by Maker to purchase T-bills). These transactions should be facilitated through a multi-layered legal structure comprised of:

  • TACO & SUBS, LLC, a Cayman Islands limited liability company, is a wholly-owned subsidiary of TACO Foundation, an exempted limited guarantee foundation based out of the Cayman Islands.
  • Leeward Management Limited, a Cayman Islands ordinary resident company engaged by TACO Foundation to act as Director Agent.
  • BlockTower Capital Advisors LP, a Delaware limited partnership, is an institutional investment firm supervised by the SEC.
  • Ankura Trust Company LLC, a New Hampshire state-chartered trust company, acts as an independent, conflict-free indenture trustee, loan administrative agent, escrow agent, creditor representative, and other trustee services.
  • Coinbase has been chosen as the primary exchange and custodial platform for executing transactions related to the Ethena protocol.

The flow of funds specifics:

  1. Leeward Management receives deployment instructions from a specific email address associated with the Maker’s Ecosystem team. The resolution indicates the amount of USDC to be deployed into the Ethena Protocol and the acceptable slippage threshold.
  2. TACO & SUBS’s instructions are also emailed to responsible parties.
  3. Ankura Trust Company, as a paying agent, calls RWA015_A_OUTPUT_CONDUIT to mint DAI, swap it for USDC, and deposit it into the Coinbase Prime account.
  4. Once the Coinbase deposit is completed, BlockTower mints USDe and stakes it using Ethena’s front end.
  5. sUSDe is held in the Coinbase Prime account, subject to a multiparty approval workflow requiring at least one initiator (BlockTower) and one approver (Ankura/TACO).
  6. BlockTower confirms the completion of the deployment via email to TACO & SUBS.

The return of capital presupposes all actions done in reverse by the same responsible parties with the difference that relevant INPUT smart contracts are called.

Weak Spots Evaluated

Upon observation of the multifaceted operations, we should highlight several instances of potential vulnerabilities:

  • Email correspondence - Sending instructions over email without additional verification poses a risk of spoofing, impersonation, and other technical manipulation of the stream.
  • BlockTower indemnity - BlockTower is provided with an indemnity capped at $2,500,000 and available for 48 months to insulate the investment advisor against regulatory actions in the US. Should BlockTower need to access the indemnity amount, Ankura can provide the necessary funds from TACO’s bank account. Extended financial commitments to BlockTower are made on top of a guaranteed total minimum fee of $2,500,000 over one year.
  • BlockTower conflict of interests - BlockTower reportedly has a conflict of interest due to advising a client who is an investor and equity holder in Ethena. Other clients advised by BlockTower hold Maker-issued digital assets (MKR and/or DAI). In connection with the above-discussed indemnity provided to BlockTower, we consider the interconnectedness of the investment advisor with parties on both ends of the USDe purchase process a concerning factor that should be subject to a more detailed financial analysis.
  • Intertwining with Project Andromeda - Digital assets from the Andromeda Vault (created for the purchase of short-dated US Treasuries) are deployed to acquire USDe and stake such USDe. Among the parties involved in the operations is a subsidiary of the TACO Foundation, which Foundation was in use for Project Andromeda. As per disclosures, the digital assets used to fund the TACO Account originate from the Andromeda vault. Therefore, the user should be aware that “…the Digital Assets contained in the vault are used to back DAI’s peg to the U.S. Dollar), any losses sustained by the TACO Account as a result of the contemplated transactions may negatively affect the value of DAI, and in severe, adverse scenarios, may cause potential de-pegs of DAI from the U.S. Dollar.”

Based on the uncertainties in the above legal structure, stringent oversight is essential for implementing the proposed USDe purchase stream. It is prudent for MakerDAO to re-assess the suggested framework and critically evaluate the flow of funds mechanism in light of the deficiencies observed in Monetalis’ arrangements.

Nonetheless, this examination has been performed on the grounds of publicly accessible data. Confidential documents representing an inseparable part of such a complex legal structure may display information leading to different conclusions.

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