sUSD Depeg Update - 05/16/2024

Summary

Given the recent sUSD depeg, Chaos Labs provides our analysis and immediate recommendations to mitigate risk on the protocol.

Overview

sUSD depegged on May 16, 2024, with its price reaching a low (as of this writing) of 0.915 relative to USDC. This depeg was a result of a large sBTC/wBTC liquidity provider withdrawing, using Synthetix’s spot synth redemption to acquire sUSD, and selling the sUSD in the relevant Curve pool.

Incident Breakdown

On April 29th, 2024, in accordance with SIP-2059, Synthetix fully deprecated non-sUSD spot synths on the Ethereum mainnet. As a result, atomic exchanges for assets like sETH and sBTC were discontinued, with users being required to redeem these synths for sUSD.

A relatively dormant address deposited 87 BTC in the sBTC/WBTC Curve pool over the course of several months in 2023. This pool’s liquidity was heavily concentrated, with three accounts providing the majority of liquidity, including this initial user.

As a result, 9 days ago, one of these addresses called remove_liquidity_one_coin in WBTC (as well as another calling remove_liquidity followed by a sBTC-WBTC swap within the pool), effectively performing a swap of sBTC for wBTC, leading to a sBTC depeg to .93-.94. This was subsequently arbitraged by searchers with a different sBTC pool, leading to a convergence 0.96 sBTC/wBTC, where it has remained until today.

The original depositor then withdrew their large share of the pool, receiving 70 sBTC and 16 WBTC, due to the ongoing depeg and the need to redeem. This left the sBTC/WBTC pool (and the other sBTC pool) with minimal exit liquidity for his sBTC. Thus, the user redeemed his sBTC to sUSD, receiving 4.48M.

During the 14 hours between redeeming sBTC and obtaining the sUSD, the user swapped USDC and crvUSD for wBTC to approximately maintain some of their initial BTC exposure. After receiving sUSD, they periodically sold it for USDC/T within the sUSD curve pool, which led to a depeg to .93.

The user still owns 1.76M sUSD, which may be sold if and when the price reverts. Given the current discount, we note that there is an incentive to repay sUSD debt on Synthetix, as the asset is hard coded to $1 within the protocol. However, this has not happened yet.

sUSD Exposure on Aave

sUSD is listed on Aave V3 Optimism as a collateral asset and Aave V2 Ethereum as a frozen, non-collateral asset.

Chain Current Supply Supply Cap Current Borrows Borrow Cap Utilization Borrowed Against ($) E-Mode Borrowed Against LT E-Mode LT
Optimism V3 9,560,000 20,000,000 4,450,000 13,000,000 46.45% 3,130,000 2,950,000 75.00% 95.00%
Ethereum V2 2,190,000 Frozen 1,020,000 Frozen 46.57% - - - -
Overall 11,750,000 - 5,470,000 - 46.52% 3,130,000 2,950,000 - -

Beginning from May 7th, we can see that nearly 5M sUSD have been deposited, 1.57M of which was deposited in a single transaction as the depeg accelerated.

Untitled - 2024-05-16T133020.059

Overall, the sUSD market on Optimism has deleveraged since May 7th, with 8.6M sUSD deposited and repaid, relative to 3.6M borrowed and 1.4M withdrawn. We note that borrowers are incentivized to repay their debt when sUSD’s price is below $1, given that that is where they borrowed the asset.

Untitled - 2024-05-16T133021.696

Liquidations

Liquidations have thus far been minimal, totaling just 2,398 sUSD, with the largest being $1.38K USDC.e repaid to liquidate $1.39K sUSD.

Next Steps

  • Temporary Freeze of the sUSD reserve on Aave V3 Optimism- as a precautionary measure, and given the ongoing depeg and the size of the market, we recommended the Aave Guardian freeze the sUSD Optimism V3 market as an immediate step to prevent any additional growth or leverage.
  • Future Parameter Updates: We will follow up with further recommendations on sUSD parameters, including LT, LTV, supply/borrow caps, and stablecoin E-Mode parameters.
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Over the past day, the sUSD peg has slowly started to recover; however, it remains depegged at approximately $0.96. Following our decision to freeze new supply and borrowing, we recommend further reducing exposure to sUSD on Aave v3 Optimism by setting the LTV to 0. This ensures that no new sUSD collateral positions can be opened, including in E-mode.

Specification

Chain Asset Current LTV Rec. LTV
Optimism V3 sUSD 60.00% 0%
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AIP-107 has been published for this proposal, with voting starting in less than 24h.

Thank you in advance for your participation in the vote.

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Recent update from Synthetix outlines plans to scale sUSD, increase sUSD liquidity incentives, and transition sUSD & SNX to the V3 system via migration beginning in June.

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The link to AIP-3107 appears broken:

failed to resolve /ipns/app.aave.com/governance/proposal/v3/107/: no link named “proposal” under bafybeifvnuvy4aa7vr75mxrrmxig6imp55m2jv766skrruxkr6lqf5455u

This appears to work, though: Aave - Open Source Liquidity Protocol

hey @ChaosLabs was asked to answer questions here, so what is the basis of these recommendations? Like from what i understand if things go south on the price, people get liquidated and that’s the end of the story. Is it because of the slippage on that liquidation or what? People can bridge sUSD from L1 to L2 instantly (or 1 week from L2 to L1), where there is more liquidity…
Happy to answer questions, but synthetix is way over collateralized atm, and there is no redemption mechanism for pressure on that ratio, people will repay their debt over time and the peg would improve… I understand you guys want to go ahead and be pro-active in your engagement, but IMO it’s kind of bad faith situation with aave integrators to just pull the plug at the first sight of price pressure… I think if it’s just a question of liquidation penalty, probably that could be increased to make it more worthwhile for liquidators, but aside from that, i fail to see why you guys freeze borrowing of susd…

2 Likes

Thanks for your response @kaleb. While sUSD is highly overcollateralized and the soft peg mechanism via cheap debt repayments is sound, the current state of spot synth deprecation can lead to short-term price depegs. This occurs when users perform redemption-then-dump actions, exacerbating the depeg through liquidations due to minimal liquidity. Given the current distribution of external spot synth assets in circulation and the current (decreasing) discount rate of 60%, we can potentially expect an uptick in large withdrawals over the next few weeks.

Screenshot 2024-05-19 at 13.38.47

Additionally, the asset being listed and primarily utilized through e-mode intensifies this issue. Increasing the liquidation bonus is a sound strategy, but it results in more debt needing to be paid off to restore an account to a healthy state, since this bonus is taken from the collateral itself. Given the state of sUSD on-chain liquidity during a depeg, this could potentially worsen the price depegging. As a result, we would like to see an increase in sUSD on-chain liquidity and a monitor the decrease in the circulating supply of other spot synth assets as they are redeemed, before moving forward with a potential relisting.

1 Like

I understand these concerns, but I believe chaos labs should also take into account the following:

  • a lot of the money that remains is zombie dead money that would in all likelehood never get redeemed, since it’s wasn’t being used for farming and hasn’t been moved in a long time. Could be related to loss of private keys by the users.
  • as the discount rate is lowered further, the yield to users in sUSD terms is also lower. Should the user ask for redemption at parity, governance can decide on the right course of action, in order to limit the impact on the peg
  • the proposal that will be put forward to synthetix governance is 1 more DR change and then a slow process that would take years to fully de-skew the debt pool
  • large stakers have signaled their intention to purchase sUSD at discount, as it represents a huge windfall for them. Hence the peg has more or less stabalized and the sBTC users fully got out of synths

I am sure with a limited market size and proper liquidation penalties, would help lean on your concerns in continuing to provide users with a on-ramp/off-ramp base. But I leave it up to you guys to run the necessary analysis with what I provided and accordingly update your proposals.

@ChaosLabs To clarify any existing sUSD longs or shorts won’t be effected or liquidated, even if there currently in e-mode. This only affects new positions?

@ChaosLabs I have a question. Assume that a user is lending SUSD and borrowing USDC collateralized against that SUSD (in stablecoins e-mode). What happens if the LTV goes to zero (from 60% at present)? Will the position be liquidated? Is there a grace period to rectify e.g. repaying the USDC and withdrawing the SUSD? If there is a grace period to rectify, how long will it be to ensure there is sufficient notification?

Hi @Daniel, no existing positions will be affected or liquidated. Setting the LTV to 0 simply means new sUSD positions cannot be used as collateral.

@snx, as mentioned above, reducing the LTV to 0 does not lead to the liquidation of existing positions. The parameter that defines liquidation is the Liquidation Threshold, which is not being updated in this proposal.

@ChaosLabs since the soft peg has since fully recovered, and knowing this:

and that your primary concern seems to be related to the effect of the last discount rate change on the peg,

  1. does your current recommendation change?
  2. would you be in favor of increasing the LTV back to 60% after the next discount rate reduction and once the perpetual linear discount rate reduction is in effect?