TL;DR:

• High risk loans skyrocket to $11B

• Liquidations increase $4.5M due to volatility

• Available Liquidity tight among stables and ETH

• LRT netflows remain negative as users unwind leverage restaking trades

• Understanding duration Risk: The risk factor quietly growing in the market

• Featured Dashboard: Morpho Risk Radar

Risk Pulse and Radar Highlights

New tETH Market on Aave

Source: Aave Risk Pulse

• New Aave market for tETH launches on Aave v3 Core Instance

• Some controversy on the asset launch as the asset is already a wrapper of leverage staking strategy on Aave

• Concerns in social channels of leverage concerns as the asst is allowed as collateral against stables

Ethena is Now the Largest Supplier on Aave

Source: Aave Risk Radar

• Ethena has recently become the largest single address supplying to Aave v3 Core Instance

• It is the largest supplier for both USDC and USDT

Current Event Risks: Duration Risk

Duration Risk ETH

One of the most effective strategies in Ethereum recently has been leverage (re)staking. Instead of just staking ETH for the standard yield, users stake ETH through protocols like Lido or EigenLayer and receive liquid staking or restaking tokens (LSTs/LRTs). These tokens can then be posted as collateral in lending markets to borrow more ETH, which is restaked to generate additional LSTs/LRTs. By repeating this cycle, users build a leveraged position: their staking rewards grow faster than simple staking because they are earning yield on both their original ETH and the borrowed ETH, though with the added risk of liquidation.

Source: Aave

We saw this trade begin to fall apart last month when ETH borrow rates began to spike on large lending platforms such as Aave. This created a negative carry environment for this trade which resulted in many users trying to exit. The issue is there is an asymmetry in entering and exiting this trade in terms of how long it takes. Due to insufficient liquidity in the markets for users to easily swap to unwind this position, users need to unstake their liquid tokens to get back the underlying ETH to repay and unwind.

Source: Validator Queue

This mass unwind is bottlenecked by how the unstaking queue on Ethereum’s beaconchain operates. As more validators seek to exit, the queue to exit gets longer. This queue has recently hit its all-time high length taking almost 16 days for a validator to exit. As leverage (re)stakers can’t unstake all of their collateral at once, they need to unwind the leverage loops one at a time, with each loop needing to wait for the unstaking period before the next loop can be unwound. 

What does this mean for the leverage (re)staking positions?

• At a 16 day unstaking queue, a users with ~10.5x leverage would take almost 1 year to unwind (assuming queue remains the same length)

• This can lead users to take on increased risks of a potential liquidation or high slippage environments if they decide to perform swaps on the market to deleverage

Duration Risk Stables

With the growing popularity of basis-trade and DeFi strategy backed stablecoins, there has been increasing leverage using these assets to earn higher yields on stables. Compared to the ETH duration risks above, the stablecoin duration risks come in varying designs that need to be accounted for based on the strategies a user is deploying. Some of the key duration risks include:

• Redemption/Unstaking Periods: The time it takes to redeem an asset for the underlying asset or more liquid asset (i.e. USDC or USDT). This redemption period is usually a fixed period of time, as opposed to the dynamic unstaking queue of ETH, but can vary depending on the asset. Redeeming from an stablecoin backed by a basis-trade, DeFi vault, or RWA will have varying redemption periods and users should understand their duration exposure before entering a position

• PT Maturity Dates: The time before a PT matures and has a 1:1 value with the underlying asset. This duration risk is more nuanced as users can more freely exit the position (given liquidity conditions) but selling a PT before maturity can leave the user exposed to price action on the asset which could lead to selling at a loss.

While stablecoins in this category only make up ~6% of total stable coin supply in DeFi, these assets are a core component of many strategies in the market. Unlike the fairly stable yields offered by ETH staking, these stablecoin APRs are more volatile as they often are connected to funding rates in the market. This can lead to larger swings in the carry which means net APYs on leveraged positions can become negative very quickly. This means that highly leveraged positions can see their days to liquidation shrink quickly during sustained swings in the carry rate.

Feature Dashboard: Morpho Risk Radar

Today we have announced the launch of our newest Risk Radar dashboard for Morpho. With currently almost $10B in assets supplied, Morpho is one of the largest lending protocols in DeFi. Its isolated market design permits collateral risks to be compartmentalized allowing lenders to customize their risk exposure and borrowers to increase their liquidity efficiency.

Resiliency

Source: Morpho Risk Radar

• Track asset volatility to determine leverage before borrowing assets

• Track volatility trends for adjusting leverage to avoid liquidations

Exposure

Source: Morpho Risk Radar

• Lenders can track the total collateral exposure of a metamorpho vault

• This allows users to choose the vault to deploy into based on their risk profile

Efficiency

Source: Morpho Risk Radar

Source: Morpho Risk Radar

• Track number of liquidators in a market

• Larger numbers of liquidators generally signals more efficient liquidation markets

• Sustained open liquidations can signal inefficient liquidation markets and risks of bad debt

Stay informed, manage risks wisely, and stay liquid

Disclaimer: This newsletter is for informational purposes only and should not be considered financial advice.