Gauntlet recommendation to freeze CRV and set CRV LTV -> 0 on Aave v2

[eboado]

My opinion on the topic:

1. The exposure of Aave v2 Ethereum to CRV is too big, there should not be much doubt about it.
2. There is not much reason to think that the big position of CRV is trying to execute anything against Aave. It is from a long-term user, who historically has been actively maintaining his collateralization. Even these days, checking on-chain activity is clear that he is trying to de-risk positions.
   Additionally, Curve is a pretty active project, with a big ecosystem around. It is not something measurable but sounds ridiculous for its founder (with huge exposure to it) to look for a liquidation.
3. Market is how it is at the moment, and still, the HF is at acceptable levels. Obviously, the sheer size of the position is what creates the risk, but only looking at that is simplistic.
4. Talking about how risk should have been controlled before, calling out some mechanisms of Aave v2 gives close to zero value. That is a conversation to have in parallel, but the effort now should be simply de-risking if desirable.

Regarding the proposed actions (and submitted AIP from @Gauntlet):

• Freezing CRV on v2. The exposure to CRV collateral is too high on Aave v2, that is clear. But there is not really any mechanism to reduce (fast) that without a debt ceiling.
  Let’s assume the CRV position goes close to liquidation. At that point, the user can mobilize non-CRV funds to repay or refill CRV. Considering the current size of CRV in his positions, seems remote he has a meaningful % of it available to refill. That means that the additional exposure from that potential refilling will not really change much negatively to Aave, but can make a bit of difference in the user protecting his position.
  But if CRV gets frozen, he will not be able to refill.
  So AGAINST freezing.

• LTV to 0 on Aave v2. LTV is a soft protection on Aave v2, with only Liquidation Threshold affecting Health Factor and influencing on the liquidation price. Changing LTV to 0 will disable new borrowings by average users, but doesn’t really change anything at the core.
  Fundamentally, feels just correct for CRV to not have additional borrowings associated, but in my opinion, makes not much difference.
  So ABSTAIN on LTV 0.

[ChaosLabs]

Summary

The freezing of this market is a train that left the station over 12 months ago. The top CRV account holds a massive position in a market starved of liquidity. If we agree that we’re already knee-deep in exposure, a freeze at this stage is more of a token gesture than an effective strategy. It would only serve to handcuff an account that has historically shown sound management, hindering its ability to top up. Instead of cosmetic measures, we should zero in on impactful solutions involving additional LT reductions and increasing the RF with regard to CRV and broader V2 markets.

Analysis

In the context of the V2 framework, the scarcity of risk levers considerably narrows our operational capabilities. While freezing can offer some advantages, it concurrently presents potential obstacles. The upside is clear - freezing limits additional CRV risk exposure. However, a freeze could unintentionally trigger heightened levels of FUD, exacerbating the concern already sparked by this post and potentially accelerating a CRV depreciation. Following a freeze, account holders are precluded from topping up, and given the prevailing sparse market liquidity, the trajectory toward bad debt could be alarmingly precipitous.

It’s worth noting that CRV’s total supply has exceeded $100 million in markets with declining liquidity for over a year.

$CRV supplied to Aave has posed an asymmetrically large risk for at least the past 12 months.

The opportune moment to propose a freeze was in the past. As of now, we’re applying a superficial solution to a much deeper issue. Our simulations show potential bad debt amounting to tens of millions, given the unprofitability of liquidations due to insufficient liquidity. Although capping the exposure seems appealing now, it fails to address the core issue.

Historical analysis of the top position shows that the user has been active and has been protecting their wallet health over time.

Freezing the market would block the user from doing so. Furthermore, we must acknowledge that a freeze, immobilizing large CRV positions, could incite significant market turbulence. In this regard, a new economic attack vector has surfaced, potentially creating a vulnerability for a speculative attack on the CRV token. Speculators recognizing this potential setup, particularly if well capitalized, are likely evaluating the risk-reward characteristics of mounting an Avi-style attack. For stakeholders who maintain a long-term bullish stance on CRV and aim to maximize accumulation, this scenario, where the price could depreciate rapidly, presents an opportunity to repurchase at a considerable markdown; thus, such investors can be very patient in their accumulation plans due to the current unfolding series of events.

Conclusion

As reiterated throughout this discussion, the implementation of a freeze is a severe measure and should be reserved for scenarios where it has the potential to enact material impact. In the case of CRV, Aave has been in a state of overexposure for over a year, and the right time for a freeze was then. Although not fiercely against a freeze, at this moment in time, its impact will be negligible and potentially very counterproductive. The market is highly volatile, and the top account holder has consistently demonstrated active risk management and maintenance of their position’s health. Regarding CRV, given V2’s high vulnerability to market volatility, we advocate against freezing, especially given the top accounts’ history of active risk management. We will be following up shortly with an ARFC to reduce CRV LTs.

[X38x]

Although I’m not against freezing the CRV market, I agree with @ChaosLabs: freezing won’t have too much of a positive impact. It’s too late, the risk is already there and freezing won’t fix it.

The obvious way forward is reducing CRV LTs:

• it will increase the ratio between the collateral and the debt;
• it is the only way Aave can force the debt repayment.

[Zer0dot]

Thank you to @Gauntlet and co for bringing this discussion up!

Here are my thoughts.

Freezing the market, as far as my understanding goes, would only prevent the user from adding to his CRV position. Why would we do that?

The main, real in my opinion, risk is the severe lack of liquidity CRV has, as outlined by folks in this thread. Whether it’s 1 or 1000 positions, CRV is too risky on V2 right now.

If we want to reduce exposure, we should do so cautiously and wisely.

V2 in and of itself is outdated, and we should push users to migrate to V3, where there are a lot more risk controls. Not all positions can be migrated since V3 has an isolated debt ceiling of ~20MM, but I think proper risk management is worth the potential loss in TVL.

Off the top of my head, and to encourage V2 → V3 migration anyway, why don’t we just raise rates and RF? Keep supply rates low, and borrow rates high. We could do so over multiple proposals, gradually over time if needed. Make leaving V2 a no-brainer, but let’s not shoot ourselves in the foot by rushing into it.

Proposal

There are much more well-equipped people here to figure out if this is a good idea (and the exact numbers), but I propose to gradually raise rates and reserve factors on major stablecoins in V2.

This way, users are incentivized to leave V2.

This will cause a net decrease in protocol-wide TVL, but a net increase in V3 TVL-- resulting in less need to constantly worry about the outdated V2.

[ChaosLabs]

@Zer0dot this is one of the actions we’ve proposed and intend to pursue further through an ARFC

@ChaosLabs

Instead of cosmetic measures, we should zero in on impactful solutions involving additional LT reductions and increasing the RF with regard to CRV and broader V2 markets.

Furthermore, we have put forward a proposal to lower the LT and LTV for CRV on V2 Ethereum, which can be found here.

[BlockEnthusiast]

Don’t think looking at asks today is representative of the speculative demand in the event of a large squeeze. I do think its being underestimated.

If we look at the past for guidance we can see during the Avi situation that the attack triggered a massive increase in volume, far more than the price crash earlier in the month.

Figure 1

Prior to actual liquidation, mostly covering the large price drop which triggered Michael to deposit more CRV (this includes only DEX volume)

Figure 2

Less granular (day instead of hour), but extends through liquidation event (only dex volume)

Figure 3

breaks down where liquidators sourced CRV

(images taken from an article I wrote on the Avi events found here)

If we look at Figure 3, we can see that ~35% of CRV used in liquidations was sourced from new debt. Likewise we can expect a lot of recycled CRV generating new debt to handle the liquidation in this instance. While there is less borrower power in this direction, there is a much larger collateral buffer to protect the protocol from bad debt.

Looking at figures 1 and 2, we can see that looking at bid and ask activity during minimal volatility is much less than during periods of high volatility. An even bigger difference in speculative demand exists during periods of publicly followed liquidations.

I expect that off chain and on chain interest is being sufficiently underestimated, as it was during the last event.

[BlockEnthusiast]

I agree the better focus should be to encourage migrating loans from v2 to v3.
A migration of this kind would naturally increase the cost to borrow on v2 and soft push repayment or migration of the risky position, while allowing more collateral to be deposited if desired to reduce the likelihood of liquidation.

[Pierandrea]

Hello everyone, I wanted to share a dashboard I created using Flipside to monitor the current status of Michael’s position. You can access it here: CRV - A possible liquidity Crunch? | Pierandrea | Flipside

This situation serves as an interesting example of the ongoing need to learn and update our DeFi products. While isolating to Aave v3 may help mitigate the risk, it does not provide a comprehensive solution for potential future scenarios like this. To prevent such issues, active monitoring of collateral liquidity (and decentralization of LPs) on decentralized exchanges should be implemented.

Kudos to Gauntlet for their remarkable work!

[0xkeyrock.eth]

We’re not supportive of this action to freeze the asset as this is not how DeFi works. We agree that it worth paying attention to wallets at risk as general practice but are in line with the comments made by @MarcZeller and @ChaosLabs. As @ChaosLabs mentioned if there was a consensus to do a freeze, that should have been done long ago.

The position is still relatively healthy and we can see on-chain how actively managed it is.

[santinomics]

@Zer0dot

Off the top of my head, and to encourage V2 → V3 migration anyway, why don’t we just raise rates and RF? Keep supply rates low, and borrow rates high. We could do so over multiple proposals, gradually over time if needed. Make leaving V2 a no-brainer, but let’s not shoot ourselves in the foot by rushing into it.

@BlockEnthusiast

I agree the better focus should be to encourage migrating loans from v2 to v3.
A migration of this kind would naturally increase the cost to borrow on v2 and soft push repayment or migration of the risky position, while allowing more collateral to be deposited if desired to reduce the likelihood of liquidation.

Probably a bit off topic but it’s important to avoid assuming that changing parameters in Aave v2 will automatically result in a seamless migration to v3. Users have the freedom to close their positions and withdraw their funds from the protocol. It’s crucial to consider alternative options provided by other protocols, as well as the possibility of closing positions to reduce risk.

This discussion surrounding migration strategies is not exclusive to Aave, but also extends to other platforms like Compound, which is also undergoing a migration from v2 to v3. Given the complexities involved, it is advisable to adopt a phased and well-thought-out approach when implementing any changes. Careful consideration should be given to ensure a smooth transition and minimize potential disruptions for users.

[Gauntlet]

The AIP has not passed. In light of this, we thought it would be helpful to provide more clarity on the rationale for freezing CRV.

Why does Gauntlet recommend freezing CRV on Aave v2?

Freezing prevents the continued excessive buildup of CRV, preventing further concentration. We don’t know how much CRV the user has on the backend that he can add to add this concentration.

• The tradeoff is that user cannot use CRV to protect their position should it become liquidatable.

  • This is the point - freezing compels the user to either provide additional collateral or repay their debts. There is speculation that the user may be unable to access funds to repay their USDT debt, but this cannot be measured. It’s important to note that the user has already started repaying a portion of their debt since the proposal was introduced.

• Unfrozen CRV incentivizes the user to protect their position by depositing CRV, which will add further concentration risk, rather than repaying their debt.

We cannot predict how liquidity and market conditions will evolve in the future, so we cannot assign a probability to this. Consequently, adding more CRV to this position will increase future risk. We want to avoid a situation where the position has a higher amount of CRV as collateral and the liquidity of CRV has further decreased, making it harder to remove the position.

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Why do increases in CRV collateral add additional risk?

• Increases in CRV collateral add insolvency risk linearly with respect to the marginal increase in CRV position, which can be superproportional with respect to the original position. In other words, increasing the CRV position by x% can increase insolvencies by MORE THAN x%.

• Given the user’s current position, suppose there was an initial CRV price drop that forces the user to adjust their positions, and the user needs to either repay USDT debt or refill CRV collateral to maintain a “safe” HF. For example - suppose the user’s target HF is 1.6, and CRV drops 16%. That means the user’s HF has dropped to 1.4 (supply 288m CRV, borrow 62m USDT, CRV price $0.62, current data as of 2023/06/16 23:30 UTC). This implies the user either needs to repay 7.7m USDT or deposit 41m CRV to return the HF to 1.6. The following heat map shows the relationship of increased insolvencies between adding CRV collateral vs repaying USDT debt when HF is held constant, to the CRV price drop and the amount of additional CRV added.
  

  • Let the initial drop be drop_init (the above example is 16%). Then the user’s default insolvencies, assuming liquidations occur after the price has stabilized after a big drop of x%, are
    

  • The user’s insolvencies after repaying are
    

  • This implies that the insolvency is linear with respect to how much CRV we refill, and by how much CRV price drops by

  • The user’s insolvencies after refilling with CRV are the same as the user’s default insolvencies since USD balances remain the same.

  • Therefore, refilling relative to repaying debt can increase final insolvencies by 1/(1-drop_init) - 1, which is the same as the CRV refill amount.

• Liquidations will mostly occur once the price has stabilized, if the stabilized price is lower than -70%, liquidations will drive the account towards realized insolvency. HF is currently 1.7, and currently, CRV needs to decrease by 40% to trigger liquidations and 70% to trigger insolvencies. Our simulations show that there is current liquidity levels can only support ~$6m in liquidation as CRV decreases in price. Drawing parallels to USDC depeg, liquidity deteriorates as CRV price drops, thresholding liquidation volume. Only when the price stabilizes and begins to trend flat does liquidation volume increase.

  • As a result, final_price(CRV) stabilizes at a price less than the min_price_no_insolvency(CRV), any liquidation will continue to drive the HF downwards. Moreover, if increased CRV supply from refills can continue to exert downward pressure on the stabilized CRV price, so the more CRV refill/supply, the lower the effective liquidation price could be and the greater the harm to the user HF.
  • To illustrate the potential speed of liquidations, during the previous CRV incident on 2022-11-22, 50m of CRV debt was repaid in 1 hr of time as CRV went from 0.61 to 0.71.

• The user has the capacity to greatly increase their CRV position. For context, the user’s CRV position has doubled over the past half year. The user has roughly 150m CRV on other lending platforms, and 60m CRV unlock in the next year, which means he has the capacity to potentially increase their Aave v2 position by almost 70%.

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On preventing borrow from increasing

• This was our intention behind setting LTV to 0, and we look forward to improvements across Aave v2 to make that check more rigorous and non-circumventable. As we previously discussed, managing the user’s position requires addressing both sides of the problem. This involves preventing further supply growth and restricting the user from borrowing more in order to minimize risk.

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On freezing being too extreme

• This is the philosophical problem of DeFi - Gauntlet is looking to absolutely minimize bad debt on Aave that can result from market risk. At times, the best course of action is to intervene in a fairly extreme manner, similar to our pause suggestions during the USDC depeg. As DeFi gets more developed, we look forward to new automated, algorithmic mechanisms that serve as killswitches to stop normal behavior in abnormal events.