The discussion around the proper LTV is secondary to the community decision between (1) a more inclusive E-Mode with a lower LT and (2) a less inclusive E-Mode with a higher LT.
Since the Snapshot ends tomorrow, we propose that the votes for options 1 and 1A be combined and treated as a single option, reflecting the community’s preference for a more inclusive E-Mode setup. The determination of the appropriate LTV can be addressed at a subsequent stage.
Our primary consideration remains to enable the inclusion of all USD stablecoins while minimizing the likelihood of liquidations for retail users through the margin between LT and LTV while safeguarding the protocol with more conservative LT.
Note: We stress that we don’t believe EURS or agEUR should be in E-mode for any market.
Regarding the comments above:
We have observed that Gauntlet is utilizing selective data and cherry-picking examples to discredit Chaos’ analyses, which can be misleading. In the interest of transparency and impartiality, we aim to address each point in a balanced manner to present an objective proposal to the community, thereby enabling voters to make informed decisions. It is essential to remember that this vote should not be perceived as a competition between the proposals by Chaos and Gauntlet but instead as a choice between alternate methodologies. Our objective is to present our proposal equitably and unbiasedly, allowing the community to make informed decisions.
Specific Responses
We would like to address several points from your previous comment:
We must dispel some misleading statements regarding regular borrowing on Aave v3 sidechains. In E-mode, LT and LTV are shared across all assets. From a risk management standpoint, we must consider the LTVs of the riskier assets for option 1A, which includes all stablecoins. Please see the examples below:
| Token | Market | LTV | Comment |
|---|---|---|---|
| DAI | Avalanche/Polygon/Optimism | 75% | |
| USDT | Avalanche/Polygon | 75% | Isolated |
| MAI | Avalanche/Polygon | 75% | Isolated |
| FRAX | Avalanche | 75% | Isolated |
| EURS | Polygon | 65% | Isolated |
| sUSD | Optimism | 60% |
Making capital efficiency or risk statements based upon the risk parameters of the safest asset, in this case, misses the full picture and functionality of E-Mode. Option 1A still significantly improves capital efficiency for riskier assets without sacrificing appropriate risk management practices.
We are in agreement that conservative LTs are crucial to risk management on Aave. However, the importance of setting sensible LTVs cannot be understated. The below graphs are from Gauntlet’s report on Aave. It is worth noting that in the report, Gauntlet acknowledges the significant impact of LTV on the net insolvent value of an asset, as demonstrated by the graph below:
The spread is crucial as it creates a buffer in which retail users are not liquidated, especially those not actively managing their accounts. This is also acknowledged in Gauntlet’s report and is a relatively straightforward concept.
Note: We acknowledge this report is a few years old, and we do not leverage its results or methodology in our analysis. However, it is relatively straightforward that the LT-LTV gap provides a buffer for users, both by preventing liquidations and, as Gauntlet states, by providing users with time to update their positions:
For instance, if we have a stablecoin-stablecoin loan (e.g., USDT as collateral to borrow USDC), then providing a buffer (liquidation threshold > LTV) gives a borrower more time to recollateralize a loan. (https://gauntlet.network/reports/aave).
Apart from providing users with a time buffer, we also protect them against depegs of a size approximating: 1 - LT/LTV. Our spread of 7% protects users (borrowing at or near the LTV) from an up to 8.75% deviation in stablecoin prices, whereas a spread of 3% only protects up to a 3.57% deviation. The math underpinning these percentages can be found in our paper, as well as graphs on when deviations have historically exceeded 3.57%. In our paper, we only considered DAI, USDC, LUSD, and USDT (current Ethereum tokens)
Gauntlet has also alluded to the importance of LTV-LT spreads in the Q&A section, in their response above:
This comment misses the point of lowering LTV. We suggest using a lower LTV to set guard rails for less sophisticated users, which comes from a concern for the users of the Aave protocol, not as a means toward avoiding Aave protocol bad debt. Furthermore, the fact that users borrow at lower LTVs than the maximum LTV for USDC is not an argument in favor of increasing the LTV, similar to how we do not increase the speed limit on the highway simply because drivers are driving well below the current limit. Much like LTV and LT, the speed limit is meant to prevent users from taking more risk than is sustainable according to relevant risk metrics. To set this parameter, we consider the case of if/when users borrow at or near the LTV.
Summary:
Considering the volatile nature of the DeFi space, an LTV of 80% and an LT of 87% represent a substantial enhancement in capital efficiency for most stablecoins, particularly those currently isolated and possessing low LT/LTV. This approach allows a more inclusive E-Mode, mitigates bad debt via a low LT, and safeguards retail users by incorporating a sufficiently wide spread between LT and LTV.