We thank all service providers who helped refine the proposed sUSDe liquid e-Mode setup. The V3.2 upgrades introduce significant changes that require a thorough review.
Two blockers must be resolved before ARFC voting:
- Agreement on the liquidation bonus rate
- Technical limitations regarding isolation mode borrowing for GHO and USDS
LlamaRisk is working with Aave’s Service Providers to address these issues.
LT-to-LTV buffer (resolved)
We agree with @ChaosLabs, which has noted:
As pointed out in our initial note:
To ensure optimal user experience, the proposed liquid e-Mode’s LTV-to-LT buffer must safely cover all minor and temporary USDe de-pegs without triggering liquidations for borrowers using sUSDe as collateral. The proposed parameters are:
- Maximum LTV: 90%
- Liquidation Threshold (LT): 92%
- Resulting buffer: 2%
USDe’s secondary market price can be discounted up to 2% before triggering liquidations (assuming the sUSDe internal exchange rate remains fixed). As noted in our initial analysis:
It can be observed that since its onboarding on Aave, the USDe discount never exceeded 20 bps (-0.2%). Furthermore, extended pricing data shows that the maximal historical market price discount was 36 bps (-0.36%).
USDe’s discount has never reached levels that would trigger e-Mode liquidations. Given USDe’s adequate liquidity, we support the proposed LT-to-LTV buffer.
Liquidation Penalty
The problem related to the liquidation bonus emerges when a position becomes liquidable: liquidators must navigate a potential gap between the liquidation bonus and sUSDe’s market price. Here’s how a liquidation would work in the liquid e-Mode:
- Repay the stablecoin debt
- Receive sUSDe collateral with a liquidation bonus
- Sell sUSDe collateral for USD-denominated stablecoin to realize profit
If liquidation occurs due to a >2% USDe secondary market discount, Aave prices the sUSDe collateral at this discounted rate. The liquidator receives this sUSDe with an additional liquidation bonus relative to USDe. The key risk is if sUSDe’s secondary market price de-pegs from USDe by more than the liquidation bonus. In such cases, liquidators would delay or avoid executing liquidations since they cannot guarantee a profit, exposing Aave to increasing bad debt risk.
Consider this scenario:
-
USDe market price drops to $0.97 (-3% from peg)
- Positions at max LTV (90%) now exceed 92% LT
- Their LTV becomes ~92.7%
- This triggers liquidation eligibility
-
Liquidator’s expected process:
- Repays stablecoin debt
- Receives sUSDe with a 3% liquidation bonus vs USDe
- Must immediately sell sUSDe for stablecoins to lock profit
-
Problem arises when:
- sUSDe trades at a 4% discount to USDe in the secondary market
- Liquidator’s profit calculation: 3% (bonus) - 4% (market discount) = -1%
Result: Risk-free liquidation becomes unprofitable, deterring liquidators and increasing chances of the protocol accruing bad debt.
Based on the observed historical maximum sUSDe de-peg, we propose increasing the liquidation bonus to 4%. While this de-peg occurred during Ethena’s protocol early days with lower sUSDe staking rates, the sUSDe liquidity-to-supply ratio remains comparable to those levels:
Source: Dune Analytics, 14th November, 2024
Volatile changes in perpetual funding rate yields may drive sUSDe holders to sell directly in the secondary market rather than wait for the 7-day unstaking period, potentially creating selling pressure similar to April 2024. Even temporary price discounts require sufficient liquidation incentives to ensure effective liquidations.
Assets Non-Borrowable in Isolation
Our inquiry with @bgdlabs revealed that the proposed liquid e-Mode is not technically feasible on the Main instance under current parameters. Since sUSDe is listed under isolation mode, only certain stablecoins can be borrowed against it as collateral. Stablecoins with borrowable in isolation set to False cannot be borrowed using any isolated asset as collateral. Two stablecoins in the proposed liquid e-Mode - GHO and USDS - currently have this restriction.
Liquid e-Mode does not override this borrowability parameter, preventing GHO and USDS from being borrowed against sUSDe collateral. We’ve identified several approaches to resolve this:
- Set GHO and USDS to be borrowable in isolation. The legacy version of USDS (DAI) was set to be borrowable in isolation, and therefore, the same could be done for USDS without high-risk implications. However, setting GHO to be borrowable in isolation would enable all isolated assets to collateralize GHO. This would have additional risk consequences that would need further evaluation.
- Offboard sUSDe from isolation, lower LTV, and LT to replicate the conditions from the Lido market. However, it would take significant time to make these changes as they would need to be performed gradually.
- Abstain from the proposed liquid e-Mode on the Main instance or rework it only to include assets that are borrowable in isolation.
Notably, the described problem does not apply to the proposed liquid e-Mode on the Lido market instance, where all proposed stablecoins will be borrowable as sUSDe would not be onboarded in isolation mode.