This is an archive of our post on Aave governance forum. Read the full thread here.

Summary

LlamaRisk supports this proposal and believes these changes will ensure a balanced risk profile of sUSDe liquid e-Mode. We have previously proposed a related ARFC containing risk considerations for sufficient capitalization of Ethena’s reserve fund and the needed risk adjustments. Ethena quickly stepped in and committed $10m of additional capital to the protocol’s reserve fund.

Confirming the 10m was deposited, tx hash: 0x81631a1b77f4377b10948b6d1a6b3f2ce2614bd3b51b231acd526bbc9676f192.

Consequently, we are pleased to move the discussion regarding the proposed liquidation penalty increase here.

Liquidation Penalty

Aave sUSDe’s price oracle combines the internal sUSDe/USDe exchange rate, a CAPO adapter, and Chainlink’s USDe/USD secondary market price feed. For liquidations to function properly, the current 3% liquidation penalty must exceed sUSDe’s secondary market discount. Otherwise, liquidators would need to unstake sUSDe through a 7-day cooldown period.

Our review found that a USDe de-peg could trigger a prolonged sUSDe de-peg in high redemption scenarios. While Ethena’s reserve fund could help restore USDe’s peg, sUSDe’s recovery would be slower due to high stake ratios and cooldown periods. This creates a risk window where sUSDe-backed loans could become liquidatable, but liquidations might be unprofitable if sUSDe’s market discount exceeds the liquidation penalty, potentially resulting in bad debt.

Current data shows that approximately 25% of all sUSDe supply on Aave would face liquidation if USDe de-pegs by 2.5%.

Source: LlamaRisk, 16th of December, 2024

While elevated liquidation risk is inherent to sUSDe liquid e-Mode usage, our primary concern is ensuring all bound liquidations can be executed successfully. Increasing the liquidation penalty can help mitigate the risk of failed liquidations. Importantly, this liquidation penalty adjustment would not affect the current borrower experience and would not require changes to the Loan-to-Value (LTV) and Liquidation Threshold (LT) parameters.

Constrained USDS Liquidity on Aave

Currently, ~141m USDS has been borrowed against sUSDe, which accounts for 15.2% of total borrows in the sUSDe liquid E-Mode. As discussed by @ACI, including USDS in this E-Mode has caused liquidity mismatches on Aave’s Core market instance. It has been observed that since the launch of sUSDe liquid E-Mode, utilization of this asset has sharply increased, and later on, it has started to cause liquidity shocks, which are reflected on a minute-by-minute chart.

Source: Dune Analytics, 22nd of December, 2024

Most USDS borrows (~73%) come from the sUSDe liquid E-Mode. Therefore, this exposure can be the main reason for the observed borrow/supply rate shocks.

Source: Aave, 21st of December, 2024

To achieve supply and borrow stability for USDS, further exposure to sUSDe liquid E-Mode must be limited. This limitation could be a temporary measure, which can be reverted if/when stability is reached.

Recommended Parameters

We propose the following adjustments to sUSDe liquid E-Mode:

Asset sUSDe USDS USDC USDT Collateral Yes No No No Borrowable No No Yes Yes Max LTV 90% - - - Liquidation Threshold 92% - - - Liquidation Bonus 4% - - -

(changes highlighted in bold)

Disclaimer

This review was independently prepared by LlamaRisk, a community-led non-profit decentralized organization funded in part by the Aave DAO. LlamaRisk serves as a member of Ethena’s risk committee. LlamaRisk did not receive any compensation from the protocol(s) or their affiliated entities for this work.

The information provided should not be construed as legal, financial, tax, or professional advice.