Thanks all again for the feedback and thoughts regarding the potential killswitch implementation. We provide the updated options below and plan to move to snapshot. Given Proof of Reserve is still in development and the timeline is unclear, we recommend moving forward without a Proof of Reserve trigger. Once the Proof of Reserve solution has been formalized, the community can then align on the optimal implementation for it.
The space of possible causes and magnitude for depeg is inherently unknown. Gauntlet’s position is to minimize insolvency risk for Aave in the face of an LST depeg - as a result, some of our proposed solutions necessarily trade user experience to preserve overall Aave solvency.
Killswitch levers
We provide the following levers that can be pulled in the event of a depeg.
| Lever | Description | Implementation | Effect | Reverts when | Tradeoff |
|---|---|---|---|---|---|
| A (market depeg) | Dynamic, auto LT reduction | 1. Activated when LST/BASE market dislocation > 2.5% 2. LB applied on market rate if user is healthy, otherwise applied on smart contract rate | 1. Prevent insolvencies of the riskiest accounts with highest LTV, 2. Avoid realizing insolvencies for accounts already unhealthy | When LST price increases, auto increase LT | Some positions that ultimately are healthy can be liquidated, hurting user experience |
| B (market depeg) | Freeze LST + LTV → 0 | Activated at LST/BASE dislocation of 2.5% | Prevent additional risky borrow when LST exhibits abnormal behavior | When LST/BASE dislocation goes below 2.5% | Can prevent users opening positions, affecting user experience |
| C (liquidity decrease) | Double BASE IR Curve Slope 1 | Activated if LST DEX liquidity decreases by 30% over 24 hour period, incentivizes risky position closure | Incentivize risky position closure | When DEX liquidity is no longer decreasing over 24 hr period | Can reduce profitability for traders executing leveraged LST loops |
| D (liquidity decrease) | Lower LTV to non emode params | Activated if LST DEX liquidity decreases by 30% over 24 hour period, incentivizes risky position closure | Prevent risky borrows | When DEX liquidity is no longer decreasing over 24 hr period | Can prevent users from opening positions |
Implementation for Lever A above. For context, stMATIC market dislocation has not breached the 2.5% barrier since the start of 2023.
| LST/BASE dislocation % | LT |
|---|---|
| 1.25% | 97.50% |
| 2.50% | 95% |
| 5% | 90% |
| 10.00% | 80% |
| 20% | 60% |
Options
We provide the following set of options to the community.
| Market / Smart Contract depeg protection | Market / Smart Contract depeg protection | Liquidity decrease triggered protection | Liquidity decrease triggered protection | |
|---|---|---|---|---|
| Option | Lever A - dynamic, automated LT reduction | Lever B - freeze LST + LTV → 0 | Lever C - double slope 1 of BASE | Lever D - lower LTV to non emode LST params |
| 1 (Gauntlet choice) | x | x | x | x |
| 2 | x | x | ||
| 3 | x | |||
| 4 (NAY - no killswitch) |
Again, Gauntlet’s position is to minimize insolvency risk for Aave in the face of an LST depeg - as a result, some of our proposed solutions necessarily trade user experience to preserve overall Aave solvency. Thus, we recommend Choice 0, the choice that offers the most protection. We aim to be transparent about the benefits of all the levers and the impacts on the user experience they bring. It is up to the community to align on potential killswitch options based on its risk preferences.
We recommend Lever A in addition to lever B because Lever B is a weaker lever that prevents additional insolvency risk during a permanent depeg, but does not reduce existing insolvency risk.
- Without LT reduction, all positions with User LTV > final LST fair value price are insolvent, whereas Lever A provides the opportunity for those riskiest positions to be liquidated. Here, the riskiest positions that can still be safely liquidated have a chance to be derisked with LT reduction.
- The key is that the reduction is dynamic. As we noted in our previous post, should the LST market price begin repegging, the LT increases back to the next tier. This means that sufficiently collateralized positions can no longer be liquidated.
Lever C can help reduce existing positions before potential depegs occur, likewise Lever D can help prevent additional positions from being added before potential depegs occur.
Next Steps
We welcome community feedback and we will put up a Snapshot on Monday, July 17.
Appendix
We walk through how Lever A will prevent additional insolvencies relative to Lever B. Lever A enables the ability to liquidate the riskiest positions that are still healthy, which reduces potential insolvencies.
Let 
represent the price trajectory of the depeg of the LST at time t.
Let 
represent the minimum price realized during the depeg, and 
is the final fair value smart contract price, which should equal the final stabilized market price.
Onceconverges to 
, Lever A can reduce insolvencies for all accounts with 
, which lever B cannot.
- If at time t,
, liquidation bonus is applied on the market rate. Otherwise, liquidation bonus applied on the smart contract rate.
- This provides sufficient incentive to derisk currently healthy positions, but at risk to become unhealthy, while avoiding liquidations on already unhealthy positions that can further drive them into insolvency.
Again 
can be unknown during the depeg. Thus iteratively derisking excessively risky positions - positions with the highest chance of becoming insolvent - during a depeg can prevent insolvency, especially in the initial stages of the depeg, when liquidity has not considerably deteriorated.
Ascontinues to decrease, we know that during the course of the depeg, there will exist some time 
where for 
, liquidation volume will decline dramatically due to excess slippage. However, oncestabilizes and begins recovering from
, liquidation volume will increase, as seen during the USDC depeg. Here, the following take place.
- automated LT increase to the next tier prevents sufficiently collateralized users from liquidation
- liquidation based on the current smart contract rate prevents damaging liquidations for positions with
, if current smart contract rate >has not yet been updated based on chain uncertainty. - accounts with LTV just under , in other words, the riskiest accounts still solvent, are able to be liquidated.
- This can prevent additional insolvency because is inherently unknown for future t and could further decrease.
can be less thanfor any t, even while LST market price is “recovering”. In this case, liquidating positions where 
can prevent additional insolvency, relative to only freezing the LST.
- This can prevent additional insolvency because
Asconverges to 
, with Lever A some initial accounts with 
have been safely liquidated, which Lever B is unable to do.