Overview
Chaos Labs supports listing USDe in Isolation Mode on Aave V3 Ethereum. Following is our analysis and risk parameter recommendations for the initial listing.
Note: The following analysis is conducted solely from a market risk viewpoint, excluding centralization and third-party risk considerations. We provide insights into these components; however, if the community aims to reduce exposure to USDe, adopting a more conservative supply cap or debt ceiling should be considered.
We have previously provided recommendations for listing sUSDe, the staked version of USDe. USDe is an asset minted using BTC, ETH, ETH LSTs, and USDT. Collateral is then hedged on centralized exchanges, generating yield when funding rates are positive. However, this yield does not accrue to USDe, instead accruing to sUSDe in a similar manner as wstETH. There is a 7-day cooldown when unstaking sUSDe; there is no cooldown to redeem USDe, though a multi-sig controlled by Ethena can set max redemptions per block. Thus USDe functions largely the same as overcollateralized stablecoins, albeit with additional complexities and risks outlined below.
Liquidity and Market Cap
When analyzing market cap and trading volumes of assets for listing, we look at data from the past 180 days. Alongside a speculative “shard-based” incentive structure, Ethena’s TVL grew rapidly from January to April, reaching a high of $2.4 billion, while USDe has averaged $57.88 million in daily volume. Bybit recently announced that it will incorporate USDe as a collateral asset, which may further increase its market cap and daily volume.
USDe’s rapid growth and integration thus calls for a more conservative listing approach, as incentivized growth can potentially give way to rapid liquidity drawdowns in the future.
USDe / USD Volatility
Liquidation Threshold
Considering the volatility and the correlation of USDe to USD, we recommend setting the LT to 75%. This mirrors such as sDAI and traditional stablecoins on Ethereum V3, albeit with a slight adjustment to account for the smaller liquidity and the asset’s relative novelty. Consequently, there might be slightly more variance expected in the future.
Supply Cap
Chaos Labs’ methodology for initial supply caps generally suggests establishing the Supply Cap at twice the liquidity available based on the Liquidation Penalty price impact. However, given ongoing incentives to liquidity providers on DEXes, we recommend beginning with a more conservative cap (equal to the liquidity available based on Liquidation Penalty price impact) than would usually be recommended, given the possibility that liquidity decreases once these incentives end.
Given the current DEX liquidity profile of USDe, we recommend a supply cap of 80M USDe.
Isolation Mode
Considering the size of the insurance fund and the anticipated utilization through stablecoin looping, our initial recommendation is to list sUSDe in isolation mode with a debt ceiling set at $40 million. Further insights into the projected growth of the insurance fund are provided in our comprehensive analysis of DAI post-D3M integration with Ethena.
Pricing USDe; CAPO
We recommend pricing USDe according to its market price, which serves as a proxy for its implied collateralization ratio, alongside an expected-price-CAPO upper value of 4% (thus establishing a price maximum of $1.04) to deter potential oracle manipulation. This approach accounts for the ability to atomically redeem USDe for its underlying equivalent in case of insurance fund depletion, as in expectation the market price will not deviate further from this point.
Borrowing USDe
We recommend incorporating USDe as an asset available for borrowing. While we previously recommended against allowing sUSDe as a borrowable asset, the previous considerations do not apply here, given that USDe does not incorporate yield as assets like sUSDe and sDAI do.
General Risks Associated with Ethena
The following section offers a concise overview of the external risks associated with sUSDe:
Significant LST Depeg
- Permanent LST Depeg: A permanent LST depeg could occur due to extreme validator slashing, hacks, or other unforeseen events, leading to USDe becoming under-collateralized.
- Liquidation of Ethena Hedges: In the event of a significant depeg (which is highly improbable given the current split between LSTs, ETH, and USDT), Ethena’s perpetual short positions on CEXes could be liquidated.
- Mass Redemptions for USDe: If Ethena faces mass redemptions for USDe, it could result in crystallizing losses if the protocol is required to sell an LST when it is under the peg. The primary market activity should ideally use USDT, with ETH as backup, and LST only utilized when a large proportion of USDe is redeemed within a short timeframe. Additionally, as mentioned earlier, the 7-day withdrawal period can lead to apparent short-term discounts in the sUSDe fair price, as selling effectively bypasses the queue.
Persistent Negative Funding Rates
- Insufficient Market Size: The perpetual market might be too small to absorb Ethena’s open interest, especially during periods of persistent negative funding rates.
- Drain on the Insurance Fund: A prolonged period of negative funding rates could drain Ethena’s insurance fund.
- Natural Movement to Negative Funding Rates: Ethena’s short open interest could naturally cause funding rates to move into negative territory.
From Aave’s perspective, such an event creates an effective time buffer, allowing the protocol to respond and implement measures against these risks if the DAO considers it adequate.
Slippage and Operational Challenges
- Risk of Slippage: Multiple transactions are required to maintain balanced USDe backing and optimal backing ratios. Slippage or human errors during these transactions could lead to losses.
- Impact of Slippage on Depegging: Slippage during the closure of futures hedges may be passed on to primary market actors, posing a risk of de-pegging USDe to the extent of the slippage.
For a more in-depth quantitative analysis of the risks associated with sUSDe, please refer to our comprehensive analyses on Ethena, which are available here.
Recommendations
Following the above analysis, we recommend listing USDe with the following parameter settings:
| Parameter | Value |
|---|---|
| Isolation Mode | Yes |
| Borrowable | Yes |
| Borrowable in Isolation | Yes |
| Collateral Enabled | Yes |
| Supply Cap (USDe) | 80M |
| Borrow Cap (USDe) | 72M |
| UOptimal | 80% |
| Slope1 | 9.00% |
| Slope2 | 75.00% |
| Debt Ceiling | $40M |
| LTV | 72.00% |
| LT | 75.00% |
| Liquidation Bonus | 8.50% |
| Liquidation Protocol Fee | 10.00% |