[ARFC] Proposal to Remove USDS from sUSDe Liquid E-Mode in Aave Prime Instance

Governance
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[ARFC] Proposal to Remove USDS from sUSDe Liquid E-Mode in Aave Prime Instance

Author: ACI (Aave Chan Initiative)

Date: 2024-12-18

Summary

This proposal recommends the removal of USDS from the sUSDe Liquid E-Mode in the Aave Prime instance.

Motivation:

The sUSDe Liquid E-Mode was introduced to enhance capital efficiency for users by allowing higher loan-to-value (LTV) ratios when using sUSDe as collateral to borrow stablecoins like USDS. See proposal for more context.

However, recent market observations have indicated increased borrow rates and potential liquidity mismatches involving USDS within this E-Mode. To address these concerns, this proposal suggests temporarily removing USDS from the sUSDe Liquid E-Mode in the Aave Prime instance.

The primary motivations for this proposal are:

  1. Risk Mitigation: The inclusion of USDS in the sUSDe Liquid E-Mode has led to elevated borrow rates and potential liquidity mismatches.
  2. Collateral Isolation: Until a wrapper is available to isolate USDS collateral in the Prime instance, USDS remains the primary exposure. Removing it from the sUSDe Liquid E-Mode will help manage associated risks more effectively.
  3. User Impact: This change will not negatively impact existing user positions but will prevent the establishment of new ones involving USDS in the sUSDe Liquid E-Mode, thereby safeguarding current users while mitigating potential future risks.

Specification

The proposed changes are as follows:

  • Asset Removal: Exclude USDS from the sUSDe Liquid E-Mode in the Aave Prime instance.

  • Parameter Adjustments: Update the E-Mode configuration to reflect the removal of USDS, ensuring alignment with the protocol’s risk management framework.

  • Liquidation buffer improvement:
    echoing concerns from @LlamaRisk and other service providers, sUSDe emode on both Prime & Core instances are set to increase their buffer for liquidations.

    • Increase Liquidation Bonus from 3 to 4% on e-modes on Core and Prime instances.

Current ARFC will be reviewed by Risk Service Providers and their feedback will be included in the current ARFC.

Disclaimer

This proposal is directly powered by ACI (Aave Chan Initiative). ACI did not received compensation for creation of this proposal.

Next Steps

  1. If consensus is reached on this ARFC, publish a Snapshot vote.
  2. If Snapshot vote is positive, publish an AIP vote for final confirmation and enforcement of the proposal.

Copyright

Copyright and related rights waived via CC0.

3 Likes
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Summary

LlamaRisk supports this proposal and believes these changes will ensure a balanced risk profile of sUSDe liquid e-Mode. We have previously proposed a related ARFC containing risk considerations for sufficient capitalization of Ethena’s reserve fund and the needed risk adjustments. Ethena quickly stepped in and committed $10m of additional capital to the protocol’s reserve fund.

Consequently, we are pleased to move the discussion regarding the proposed liquidation penalty increase here.

Liquidation Penalty

Aave sUSDe’s price oracle combines the internal sUSDe/USDe exchange rate, a CAPO adapter, and Chainlink’s USDe/USD secondary market price feed. For liquidations to function properly, the current 3% liquidation penalty must exceed sUSDe’s secondary market discount. Otherwise, liquidators would need to unstake sUSDe through a 7-day cooldown period.

Our review found that a USDe de-peg could trigger a prolonged sUSDe de-peg in high redemption scenarios. While Ethena’s reserve fund could help restore USDe’s peg, sUSDe’s recovery would be slower due to high stake ratios and cooldown periods. This creates a risk window where sUSDe-backed loans could become liquidatable, but liquidations might be unprofitable if sUSDe’s market discount exceeds the liquidation penalty, potentially resulting in bad debt.

Current data shows that approximately 25% of all sUSDe supply on Aave would face liquidation if USDe de-pegs by 2.5%.

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image1184Ă—584 40.7 KB

Source: LlamaRisk, 16th of December, 2024

While elevated liquidation risk is inherent to sUSDe liquid e-Mode usage, our primary concern is ensuring all bound liquidations can be executed successfully. Increasing the liquidation penalty can help mitigate the risk of failed liquidations. Importantly, this liquidation penalty adjustment would not affect the current borrower experience and would not require changes to the Loan-to-Value (LTV) and Liquidation Threshold (LT) parameters.

Constrained USDS Liquidity on Aave

Currently, ~141m USDS has been borrowed against sUSDe, which accounts for 15.2% of total borrows in the sUSDe liquid E-Mode. As discussed by @ACI, including USDS in this E-Mode has caused liquidity mismatches on Aave’s Core market instance. It has been observed that since the launch of sUSDe liquid E-Mode, utilization of this asset has sharply increased, and later on, it has started to cause liquidity shocks, which are reflected on a minute-by-minute chart.

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image1772Ă—942 123 KB

Source: Dune Analytics, 22nd of December, 2024

Most USDS borrows (~73%) come from the sUSDe liquid E-Mode. Therefore, this exposure can be the main reason for the observed borrow/supply rate shocks.

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image786Ă—126 12 KB

Source: Aave, 21st of December, 2024

To achieve supply and borrow stability for USDS, further exposure to sUSDe liquid E-Mode must be limited. This limitation could be a temporary measure, which can be reverted if/when stability is reached.

Recommended Parameters

We propose the following adjustments to sUSDe liquid E-Mode:

Asset sUSDe USDS USDC USDT
Collateral Yes No No No
Borrowable No No Yes Yes
Max LTV 90% - - -
Liquidation Threshold 92% - - -
Liquidation Bonus 4% - - -

(changes highlighted in bold)

Disclaimer

This review was independently prepared by LlamaRisk, a community-led non-profit decentralized organization funded in part by the Aave DAO. LlamaRisk serves as a member of Ethena’s risk committee. LlamaRisk did not receive any compensation from the protocol(s) or their affiliated entities for this work.

The information provided should not be construed as legal, financial, tax, or professional advice.

2 Likes
3

Current proposal has been escalated to ARFC Snapshot.

Vote will start tomorrow, we encourage everyone to participate.

4

Overview

Chaos Labs supports removing USDS from the sUSDe Stablecoins Liquid E-Mode in the Prime instance by setting USDS as non-borrowable. We also support increasing the Liquidation Bonus of sUSDe to 4% within all of the Stablecoin correlated E-Modes.

Removal of USDS from E-Mode

USDS on the Prime instance leverages a D3M module from Maker DAO to provide direct liquidity, serving as a crucial incentive to attract WETH and wstETH users to deposit within the new instance. Attracting stablecoin liquidity outside of the Core instance has proven challenging, making this D3M liquidity essential. However, the inclusion of USDS in the sUSDe Liquid E-Mode has led to a significant portion of the D3M liquidity being used for looping strategies. This dynamic has caused interest rate spikes, negatively affecting borrowers using ETH-correlated collateral.

In order to maintain a stable and efficient market that positively affects users using WETH and wstETH as collateral, we support the removal of USDS from the sUSDe Stablecoin E-Mode on Prime. However, to prevent the liquidation of existing sUSDe/USDS looping positions, which would occur due to sUSDe’s 0.1% LT outside of E-Mode, we recommend keeping USDS listed within the E-Mode but setting it as “non-borrowable.” This approach allows existing positions to remain open while preventing new ones from being opened.

Additionally, through this step, looping sUSDe with USDC will still be possible, hence potentially attracting new USDC liquidity thanks to the higher supply rates.

sUSDe Liquidation Bonus Increase

Regarding the proposed increase of the sUSDe liquidation bonus from 3% to 4%, we support the adjustment in the Core and Prime instances. Given the significant growth in the supply of sUSDe in the last months, its relatively stagnant DEX liquidity, and the growth in Aave’s exposure to the asset, we find increasing the Liquidation Bonus of sUSDe to be a prudent decision. As the topic of the Liquidation Bonus for sUSDe was previously discussed in this post, the current parameters were sufficient at the time.

While the recommended change does not address the likelihood of liquidations caused in the sUSDe market, given the significant increase in the ratio between sUSDe supply and sUSDe/USDe DEX liquidity, we expected an increased discrepancy between sUSDe market price and exchange rate at the time of liquidation. This change addresses that concern, providing an additional buffer to support the liquidator’s profitability during deviation events.

Specifications

Chaos Labs recommends the following parameters for the assets and changes covered in this analysis.

Parameter Asset Instance E-Mode Current Value Recommended Value
Borrowable USDS Prime sUSDe Stablecoins Yes No
Liquidation Bonus sUSDe Prime sUSDe Stablecoins 3.00% 4.00%
Liquidation Bonus sUSDe Core sUSDe Stablecoins 3.00% 4.00%

Disclaimer

Chaos Labs has not been compensated by any third party for publishing this recommendation.

Copyright

Copyright and related rights waived via CC0