[Discussion]stETH/risk management<> negative supply rate<>Curve incentivization/liquidity attraction

Note: Initial thoughts only, looking for more discusstion/improve over time


  • I’m just being extra pessimistic here, think being pessimistic is a good thing in bear market/now, there is apparent stETH insolvency risk, so we should act as quick(lower the risks) when we still have time
  • Assuming the readers has basic knowledge about stETH situation/risk

Simple summary:

  • Negative Supply rate: Based on stETH current ETH peg condition/price action/liquidation risks/ DEX ETH liquidity shortage, etc it Introducing certain levels of risk to the Aave protocol, so it’ll be better if we penalize stETH LP to share the risk, encourage/force them to solve the risks
    • We will introduce negative supply rates that are “Risk added rate(Fixed)” & “Depegging added rate(variable)”
  • DEX pool incentivization: Currently there is not enough liquidity(i.e. ETH) on the market to safely liquidate stETH on Aave, so we’ll use fees collated from stETH negative supply rate to use as incentivization program to incentivize/give higher yield for ETH suppliers to Curve ETH/stETH pool

Negative supply rate: (negative supply rate = Risk added rate + Depegging added rate)

  • Risk added rate:
    • -X% fixed for until stETH unstake available(the rate is fixed, amount could be settled by more discussion/research)(my suggestion is -2%)
    • Will continues until ETH unstaking available, stETH will always has risks, so it would be right to charge some amount of fees to use for liquidity inventizvizaiton or etc ways to mitigate risks in the future
  • Depegging added rate:
    • (1stETH - 1ETH) * 100 percent
    • Depegging added rate is variable rate that depends on the ETH/stETH ratio, as long as stETH values under valued than ETH, then undervalued percentage rate will be Depegging added rate amount
    • This rate is little bit high at current ratio, LPs will be unprofitable, but it’s not long term, could be solved by fixing the peg ratio, will encourage LPs to fix the ratio more strongly, and will encourage LPs to stabilize the peg in the future
  • Trade offs:
    • Aave stETH LPs will be unprofitable for a while/til the the peg recovers & stETH unstakeble
    • Discoriges stETH holders to supply to Aave
    • Aave stETH LPs in order to make stETH stay on peg, they has to constantly buy more stETH on the market to make sure the stETH/ETH peg ratio stays above or equal
    • Unnecessary panic:
      • By implementing negative supply rate, some LPs might withdraw stETH (because most of stETH LPs HF is high enough that ok with not supplying stETH as collateral)
      • Penic swap to ETH( just possible)

Curve ETH/stETH pool incentivization program:

  • Problem & reasons:
    • ETH shortage on ETH/stETH Curve pool
    • stETH depegging from ETH
    • Not high enough liquidity available to liquidate large amount of stETH(especially at bear market/now)
    • Super simple assumption that by growing the yield amount of Curve pool, we could attract more ETH liquidity
  • Incentivization fees & yield amount:
    • Aave stETH negative supply rate fees:
      • Not sure the exact rate, most likely higher than 5%APY
    • Curve & Convex & Lido :
      • Currently their r giving above 7% APY, we could ask them to increase their reward program for next 3 month or so
    • Expected yield to give with this program:
      • between 10%APY ~ 15%APY ~ 20%APY
  • Pools to incentivize:
    • Curve ETH/stETH pool:
    • (Suggestion) lunch aETH/stETH pool:
      • Working on more details
      • It’s also a not bad option that if any aETH holder r ok with stETH risks, then they could earn extra yield with their aETH token by supply to this Curve pool
    • etc

Technical aspect, implementation:

  • Looking for feedback from Aave dev team

Steps forward:

  • Improve the proposal(discussion/research/more effort) & find the right negative supply rate/adjust over time
  • Implement negative supply rate, and activate the Curve liquidity incentivization program
  • etc more details are coming

Failure & pivot:

  • It’s an experimental/temporary program, so nobody knows the outcome until testing it out
  • Assuming if the liquidity incentivization program not as effective as expected, then we could plan accordingly that stop liquidity incentivization program, and use the funds to advertise, etc ways to increase ETH supply on Curve stETH/ETH pool

Hi there,

Thanks for putting that out. I like the DEX pool incentivization part, however I am not so sure about the negative supply rate as it could have a cascading effect:

  • There is currently ~1.33m stETH supplied on v2 markets vs. ~153k ETH remaining in the Curve ETH/stETH pool and ~50k ETH on Uniswap v3 (there is some more liquidity on CEXs, but I doubt it’s material compared to the 1.33m)
  • With negative supply rate, we can assume that most of those ~1.33m stETH depositors will look to withdraw
  • Most stETH depositors are likely using it to borrow either ETH for levered stETH positions, or stablecoins; in both cases unwinding their position requires to start by swapping their stETH for ETH, which will only be possible for the first ones that manage to get through the door, with a large majority (~85% of the stETH supply) remaining stuck
  • At this point the stETH price should seriously depeg and trigger a massive liquidation event, except that there will be no liquidity for arbitrager to liquidate, leading to a large amount of bad debt for the protocol

Happy to be corrected if I am missing something.

Thanks for the first&only comment! ( :handshake:) I waited for more comments to come for few more days, so I delayed the reply for a few days. looks like nobody making any more comments!

Direct reply:

  • No it won’t cause cascading effect, it’s only interest rate charging/temporary program that only take super small portion of collateral as fee, and use to insure from liquidation/insolvency risks
    • It’ll be beneficial to protocol & LPs as well, that by having more ETH as liquidation liquidity on the market the stETH/ETH peg won’t go down too easily & Aave community won’t change the LTV/LT too low & won’t put too much additional restriction on stETH & Aave protocol won’t end up stETH insolvent & stETH won’t be frozen/unusable, etc
    • The negative supply rate amount is reasonable, it’s only addition program, that can be disabled any time if it has any negative effect/result in the future
    • I can’t imagine if anyone sells their stETH because of super small interest rate payment(and it’s only temporary program & most likely beneficial to them as whole)
    • (additional assumption based note: there is highly possibility of stETH cascading liquidation anyways, but won’t be cause by negative supply rate, but institution that holding stETH/filing for bankruptcy/etc)
  • About LPs withdrawing their liquidity because of the negative supply rate:
    • likely, expected, not a bad thing, since this is a temporary program, they can remove stETH until the negative rate ends/risk is minimized
    • I don’t believe it will effects as much withdrawal, if is really negative effects protocol interest in a big way/unexpected ways then we have the power to disable this program immediately to reattract them to stake again(Aave doesn’t have any competitors to worry about, and best available option)
  • About Leveraged stETH holders liquidating stETH to ETH:
    • It’s a concern if you view it from a third party perspective, that if we make them unprofitable by adding negative supply rate(they are doing it for earning yield in the first palace!)
      • First of all they will be most beneficiaries of this program, that by not profitable for short period of time(i.e. Paying super small portion of their collateral as negative rate along side all other 60%+ stETH(non lev bororwers) stakers contributing) the ETH on the market will grow & the price ratio of stETH/ETH will will be stronger & might come back to more halter levels
      • If I were stETH lev borrowers I would strongly support the negative rate.
      • of course if any stETH lev stakers doesn’t understand or misinformed, might cause some problems/fear, so we have to clear the time range(suggestion for 3 months) of the whole program, and educate/notify large stETH LP well that it’s the good thing/beneficial to them, etc
      • Prepare to stop the program at anytime from negative effects(prepare for just in case shitty/unexpected outcomes)
      • (additional note: the interest rate is unlike slashing/liquidation/etc one time sizable amount outflow, but super negligible amount decrease over time that won’t be noticed or effects the LP positions anyway or form & it’s only 3 month that the sum amount will be super small comparing to the individual account balances)
    • Comparing to already depeged amount/possible more depeg ratio it doesn’t make any sense to liquidate, because of super small negative rate fee that stETH lev borrowers already has pretty big lost on their positions(until now not liquidating mean = won’t liquidate at lost ), and comparing to lost they r handling right now the e.g 3 month 5% APY is super small amount, and a opportunity to make their(ie stETH LP) HF better
  • Well, about bad debt:
    • If the bad debt against to ETH is not that bad thing, but against to stable coin is worst
    • Bad debt part is quite long discussion, leave it to the future, I don’t want to get hated by stETH optimistic bros
    • In short, there r always better solutions to manage the risk, questions is it seems like nobody cares until the worst case scenario happens & always act accordingly historic data (won’t work out every time tho)

Let’s say if nothing bad happens to stETH, and we overreacted by adding negative supply rate, then it’s still not a bad thing over all

  • I don’t really see any reasonable negative side of it, but 99% positive action to everybody as whole at current conditions, no matter what future possibilities would be!

Addition info:

  • ETH2.0 unstake most likely won’t be available anytime soon, stETH risk is much worse than Aave team expected/ing, that stETH might crash to a pretty low ratio
  • The liquidity on the market/DEX pools(149,187 ETH) are not only for Aave(1,324,241 astETH), but any stETH holders can use it to liquidate(i.e. Circulating supply of stETH = 4,236,554 ), and ETH liquidity might not exist/withdrawn anytime if there is any negative news about stETH, or so
  • most of the stETH held by large holders(CEX/institutions) that if the bear market continues for long enough time & unstake is not available, then they most likely liquidate at any ratio/price!
  • Currently peg is getting better, because of large stETH holders spotted the liquidation(temporarily), might liquidate large amount at any time(i.e CEX/funds filling for bankruptcy r holding large amount of stETH & looking to OTC liquidation)
  • Less than 50% of stETH on Aave used to borrow ETH, and other 50% of it use to borrow stable coin/etc
    • I’m totally supportive of ETH borrowing with stETH as collateral(has smaller risk overall)
    • But reality is, ppl might dump their stETH as collateral, and borrow out stable coins, instead of selling on the market, because there is not as large amount of ETH on the market to liquidate for large holders
  • Worst case scenario:
    • Currently on Aave already exist possible defaulting positions that doesn’t have funds to pay back, and better options is filter out the address actively & proactively minimize the risk
    • In the future If ETH/stETH ratio gets to lower levels, and large stETH need to liquidate the position, then they will chose to dump on Aave instead(won’t effects the price slippage, will have enough liquidity to borrow against, etc)

Negative rate<>reasons:

  • Give pressure to stETH LPs
    • Make stETH LPs more actively minimize the risks by themselves that not only wait somebody else to bring back the ETH/stETH ratio, but more actively/quickly react to big price drops/flash crashes, etc
  • Filtering out the borrowers:
    • that remove/reduce the stETH supply amount by removing small individuale LPs that cares about paying fees to supply that make them unsupply until the bear market/risk matrix clear enough
  • Reducing stETH supply amount until the market stabilizes:
    • By adding negative supply rate, make it unattractive to supply stETH to Aave
  • Attract more liquidity to DEX pool
    • insure the liquidation, minimize the insolvency risks & make the stETH collateral usage conditions better or stay as good as now by having more liquidy available for liquidation & might also help the stETH/ETH ratio health, so the HF of stETH lev borrowers positions be be more safer, etc
  • etc

Additional suggestion/next steps:

  • Build a costume market for stacked ETH(i.e. stETH, rETH, etc)
    • Isolated market that: stETH/rETH only could borrow ETH, and ETH only could borrow stable coins
    • More costume liquidation, risk management, liability sharing, that lowering the Aave protocol insolvency risk & stacked ETH price monoplation/attack risks, etc
    • Etc
    • I have pretty clear idea about it, if Aave community interests, I might share more details in there future
    • ETH2.0 staking is a pretty big market, with current model(i.e Ether v2 market), impossible to grow too big size, until the unstake available, I think it worth build a costume separate market, and grow the size of stETH/rETH collateral usage amount
  • Build a aETH/stETH liquidation AMM pool on Aave protocol & only incentivize to this pool:
    • Incentivizing to Curve pool is only available best option, but it’s unpredictable that LPs might remove their ETH liquidity at anytime, if they notice any risk about stEHT(Despite taking all the high APY incentives in the pass)
    • So Aave could build a fixed staking aETH/stETH liquidation AMM, and give addition high APY, that aETH holder earns higher APY & shares the risk & Aave won’t be insolvent after all(no matter the stETH/ETH ration goes)
  • If Aave community/dev team not interested in building costume new market or aETH/stETH AMM pool, or Ether market v3 is coming soon(will solve everything), then we can still add additional risk management/liability sharing funcs to stETH on Ether v2 market