This article discusses the ongoing tension between decentralized finance (DeFi) protocols Aave and Ethena over the usage of DAI as collateral on the Aave platform. The founder of Yearn.finance, Andre Cronje, raised concerns about the potential risks associated with using unbacked assets like stETH as collateral, and noted that funding rates could eventually turn negative leading to liquidations. Other risks mentioned include oracle risks, exchange custody risks, and spread risks.
The harmonious alliance between MakerDAO, a decentralized stablecoin issuer, and Aave, a lending protocol, is showing signs of strain.
With the continuous introduction of novel technologies in the decentralized finance (DeFi) realm, a sense of unease has emerged. The potential risks associated with these innovations now force Ethereum and other leading DeFi platforms to make crucial decisions.
The heart of the dispute involves a debated stablecoin, which reflects a “basis trading” strategy, along with Maker’s Direct Deposit Dai Module (D3M) named Ethana, from Etherna.
As a crypto investor, I’d describe it this way: In 2017, MakerDAO introduced Dai (DAI) – a stablecoin that’s decentralized and overcollateralized with Ethereum (ETH). To obtain DAI, users needed to head to the MakerDAO platform and lock up their Ether as collateral while minting the tokens.
In November 2019, Maker introduced multicollateral DAI as an upgrade. Now, DAI can be secured with various cryptocurrencies, including USDC (a stablecoin tied to the US dollar), in addition to other centralized options.
Around the same period, Aave, previously called ETHLend, debuted as a decentralized lending platform in the crypto sphere. From the outset, it supported DAI as a form of collateral for loans on its system.
During the 2021 DeFi surge, the two platforms worked closely together. Through this collaboration, the introduction of D3M, jointly launched with Aave, enabled Maker to engage directly with its secondary market. This engagement was facilitated by Maker’s active implementation of a maximum variable borrow rate.
During the 2022 bear market, events unfolded unexpectedly as the failure of prominent Decentralized Finance (DeFi) platforms and significant cryptocurrency lending companies, coupled with the banking crisis that caused Credit Suisse’s collapse, applied immense stress to these systems.
Alarm bells ring as stablecoins depeg
In the 2022 bear market, we witnessed a string of bankruptcies and prominent failures, with the Terra ecosystem leading the charge in May. The downfall of Terra was triggered when its algorithmic stablecoin failed to maintain its value connection.
In just a few short days, Terra (LUNA), which had once held a place among the top 10 cryptocurrencies with a market capitalization exceeding $40 billion, saw its value plummet and practically vanish due to a downward spiral that triggered an unprecedented printing of trillions of tokens.
The failure of the Terra ecosystem caused a domino effect, eventually resulting in the demise of lending companies such as Celsius and BlockFi. Consequently, in an attempt to safeguard itself, MakerDAO made the decision to temporarily halt Aave’s D3M access.
As an analyst, I would rephrase it as follows: During the bear market, USDC, a centralized stablecoin, momentarily deviated from its peg when Silicon Valley Bank, which held approximately $3.3 billion of its reserves, went bankrupt. The peg was eventually restored once regulators intervened to protect depositors and maintain financial stability.
When the decoupling of depeg triggered concerns for MakerDAO, they swiftly called for an “emergency executive proposal” in response to their significant $3.1 billion exposure to USDC. Simultaneously, MakerDAO made a decision to withdraw their funds from Aave due to the unfavorable risk-reward ratio for depositing funds into it under prevailing conditions.
As the head of communications at Cex.io, I spoke with CryptoMoon about our decentralized autonomous organization (DAO)’s future plans. We shared that our next step is to invest in real-world assets, specifically U.S. Treasurys. By doing so, we aim to bolster market confidence in DAI and bring the network’s value composition closer to harmony.
Recent: Despite Bitcoin price volatility, factors point to BTC’s long-term success
In March, approximately one fifth of the stability fees generated by DAI were derived from real-world assets like U.S. Treasurys and short-term loans that comprise a significant portion of DAI’s collateral.
Based on Sarwate’s report, the protocol has recently chosen to reinvest its borrowed funds into stablecoins. Some investors have raised concerns over this move, particularly due to the potential risks associated with these stablecoins, which some consider akin to the risky trades of a hedge fund.
Tensions rise between MakerDAO and Aave
Over the course of time, MakerDAO and Aave have grown more competitive towards each other. In the beginning of 2023, MakerDAO introduced Spark Protocol, which is essentially a version of Aave’s v3 protocol but allows users to lend, borrow, and stake DAI directly within the MakerDAO ecosystem. This new feature, linked to MakerDAO’s D3M, presents DAI users with an alternative option similar to Aave.
In the latter part of that year, Aave introduced GHO, a stablecoin anchored to the US dollar through algorithms. They referred to it as a “decentralized, overcollateralized” asset, secured by a diverse range of digital assets such as Ether. Consequently, GHO emerged as a rival to DAI in the stablecoin market.
The data from the markets indicates that neither Spark Protocol nor Aave managed to pose significant competition based on their current performance. Spark Protocol’s total value locked amounts to approximately $2.4 billion, a decrease from its peak of over $4 billion, while Aave holds more than $10.6 billion in value locked across twelve different chains.
On the other hand, DAI’s circulating supply is over $5 billion, dwarfing GHO’s near $50 million.
In the beginning of April 2024, a significant conflict arose between these two protocols when AaveDAO considered imposing restrictions on the usage of MakerDAO’s DAI stablecoin as collateral on their lending platform, even going so far as to consider a complete elimination.
The dispute was resolved through a 12% reduction in loan-to-value ratio, but Marc Zeller, founder of Aave Chain initiative, had originally suggested eliminating DAI as collateral from Aave, the leading decentralized finance platform with over $10 billion in total value secured.
After analyzing the situation in detail, Chaos Labs recommended a less drastic reduction than initially anticipated. According to Cex.io’s Sarwate.
“Aave faced a challenging predicament with MakerDAO increasing the extension of DAI’s line of credit from 100 million to a potential short-term peak of 1 billion tokens, bringing about increased risk.”
She noted that the risk was magnified by the organization’s action to transfer some freshly created DAI into Ethena’s USDe, an algorithmic stablecoin that has raised eyebrows in the financial world due to its attempt to mimic popular hedge fund tactics.
Boiling point
The connection between MakerDAO and USDC through indirect exposure and extended lines of credit appeared to ignite controversy within the Aave community, raising concerns specifically about the stability of the USDC token.
Ethena’s USDe strategy capitalizes on price disparities between the spot and futures markets to produce returns via a technique called the cash-and-carry trade. This method involves holding Staked Ether (stETH) while simultaneously selling short on Ethereum, thereby mitigating risk associated with Ethereum price fluctuations.
In simple terms, this trading strategy is virtually unaffected by market swings since it aims to cancel out gains and losses from the crypto market and the staked ETH. Its primary source of income comes from the interest earned on staked Ethereum and the fees paid by traders holding open positions in perpetual futures contracts. These charges help keep the contract’s price consistent with the actual cryptocurrency’s value.
When the market’s purchasing power exceeds the selling power, the funding rate is positive, and those holding long positions pay off short sellers. Conversely, when there’s more supply than demand, the funding rate turns negative, with short sellers compensating long holders. Since Ethena’s inception, funding rates have predominantly been positive, enabling USDe holders to reap double-digit returns through a “delta neutral” strategy.
Detractors raise concerns that during a downturn in the cryptocurrency market, when the price of ETH futures contracts falls below the current ETH market value, stablecoins like USDe could become under-collateralized. This situation would cause funding rates to work against USDe holders.
As an analyst, I’ve noticed that Andre Cronje, the founder of Yearn.finance, has recently expressed optimism on social media about the current state of things in the decentralized finance (DeFi) world, indicating positive funding rates. However, he also cautioned that this trend eventually reverses, and when funding becomes negative, assets may become undercollateralized and get liquidated, leaving investors with unbacked assets.
Cronje acknowledged various potential hazards. Among these were risks associated with the external oracle that maintains the parity between stETH and ETH, as well as custodial risks linked to exchanges and possible price discrepancies.
As a researcher studying the cryptocurrency market, I’ve come across an interesting observation from Evgeny Gaevoy, the CEO of Wintermute, a prominent market maker in this space. Gaevoy highlighted on social media platform X that there are significant risks associated with execution and custody within the cryptocurrency market.
Sarwate pointed out that if USDe experienced a significant decline, it might cause DAI to approach a critical threshold as well.
On the contrary, if Aave were to eliminate DAI entirely, it could worsen any existing issues. Hasty delistings have the potential to cause instability and fracture formerly cohesive communities.
As a crypto investor, I’ve closely followed the developments at SushiSwap and have gained valuable insights from John Lo, a former team member now leading digital assets at Recharge Capital. According to him, Aave’s decision to reduce loan-to-value ratios was a cautious move. However, he added that eliminating DAI as collateral entirely could be an excessive step.
As a researcher, I strongly advocate for further exploration into the capabilities of the D3M module, particularly in relation to its function as a vector for flash loans. The rapid price inflation that can occur when oracles are targeted through flash loans poses a significant risk to all lending protocols. Therefore, it is essential that we delve deeper into understanding these limitations and potential mitigation strategies.
As a crypto investor, I’m constantly aware of the potential risks associated with flash loans and their impact on token prices. One such risk is the manipulation of oracles to mint excessive amounts of tokens, which can contribute to price instability or even market crashes, as was the case with Terra. Therefore, it’s crucial for us to carefully assess this risk whenever dealing with decentralized finance (DeFi) protocols that involve flash loans.
The ghost of stablecoin’s past
As a crypto investor, I’ve been following the ongoing discussion around Aave’s proposal to eliminate the loan-to-value requirement for DAI. Mark Zeller, Aave’s founder, has expressed concerns based on our protocol’s past encounters with the repercussions of less stringent minting policies. He specifically mentioned the case of Angle’s agEUR, a stablecoin pegged to the euro, which was minted into Euler and faced a security breach just a week after its launch. From my perspective as an investor, it is crucial for us to learn from these experiences and be cautious about implementing policies that could potentially lead to similar risks in the future.
As an analyst, I’d interpret Lo’s statement as follows: I’ve identified a potential risk with Ethena’s USDe stablecoin, which is centralized in nature. This means that there’s a possibility for someone to mint more USDe units at will, introducing a slight security concern. However, this risk might be mitigated by the reputational constraints of USDe. The primary threat, though, comes from potential cascading liquidations and slippage during a bank run scenario, where large-scale redemptions could lead to significant losses.
During periods of low or negative funding rates, he warned that heavy redemptions could lead investors to exit their short positions in perpetual futures contracts. If the prices of Ethereum (ETH) and Bitcoin (BTC) surge while these exits occur, slippage may result due to the market adjusting to these significant price movements.
As a crypto investor, I’d like to emphasize the importance of factoring in slippage costs when selling staked ETH over low liquidity markets. A mere 5% decrease in a stablecoin’s net asset value can significantly impact my confidence in the investment and potentially lead to further losses.
Expert: In the cryptocurrency community, Cex.io’s Sarwate expressed concerns over USDe’s yield structure, stating it brings back memories of stablecoins’ past issues. He also noted that USDe’s widespread use is just one element influencing the situation.
“Critics are reminding us of an age-old saying about the potential consequences when something burns brightly but with instability. While we may be enthused by high returns, any issues with the core asset could trigger a chain reaction of negative effects throughout.”
On the contrary, Lo expressed his skepticism towards USDe bringing “uniquely heightened risks” to Decentralized Finance (DeFi), considering it a “size-restricted, tokenized delta neutral approach frequently employed by investment funds.”
As a researcher studying the field of tokenized projects, I anticipate that we’ll see more initiatives emerge that are similar to USDe in the future. However, an important consideration is whether USDe itself will remain appealing to users once perpetual funding rates decline and potentially become negative. This shift could negatively impact USDe’s on-chain liquidity.
As an analyst, I’ve observed that numerous tokens and stablecoins face low liquidity on-chain, increasing the risk of economic exploits, such as oracle price manipulation. However, in my opinion, these situations won’t pose systemic risks similar to what we witnessed with Luna and its UST mechanism.
Despite the escalating disputes between SushiSwap and the other protocol, as a previous contributor to SushiSwap, I recognized a positive aspect. The heated debates surrounding USDe and the ensuing controversy have highlighted the importance of DAI’s governance. This issue has not only sparked extensive discussions but also increased awareness about the functioning of DAI’s governance system.
Recent: Blockchain adoption in healthcare faces serious obstacles in Germany
In his perspective, engaging in this activity serves as the most significant indication of faith in a decentralized protocol. Although precautions will eventually be put in place, it’s important to consider: How much of the governance mechanisms relates to ensuring security and how much is intended to hinder competition for established market leaders?
He pointed out that the crypto industry is typically missing out on “comprehensive, independent evaluations of collateral risks and asset risks.” Such assessments could significantly enhance the sector, according to him.
As a researcher looking into recent developments in the decentralized finance (DeFi) space, I came across the resolution of the dispute between MakerDAO and Aave. The crux of the issue was the presence of DAI stablecoins within Aave’s smart contracts. Chaos Labs conducted an analysis for Aave DAO, ultimately resulting in a 12% reduction in loan-to-value ratio regarding these DAI tokens.
It’s uncertain whether Ethena’s USDe will fail, lag behind competitors, or face some other outcome. However, with Spark Protocol and Aave’s GHO in the picture, it’s probable that these two protocols will clash or interact significantly at some point in the future.
Read More
- DOGS PREDICTION. DOGS cryptocurrency
- SQR PREDICTION. SQR cryptocurrency
- LDO PREDICTION. LDO cryptocurrency
- KNINE PREDICTION. KNINE cryptocurrency
- JASMY PREDICTION. JASMY cryptocurrency
- UXLINK PREDICTION. UXLINK cryptocurrency
- METIS PREDICTION. METIS cryptocurrency
- CLOUD PREDICTION. CLOUD cryptocurrency
- STG PREDICTION. STG cryptocurrency
- USD HKD PREDICTION
2024-05-13 16:39