The Tally Newsletter, Issue 67
Welcome back for issue 67 of the Tally Newsletter, a publication focused on defi and DAO governance. We’ll keep you updated on key proposals, procedural changes, newly launched voting systems, shifting power dynamics, and anything else you need to know to be an informed citizen.
This week we cover the return of 0 to 1 innovation in defi with:
Aave’s v3 Launch
Introduction of Sushiswap’s Long Delayed Trident Exchange
Plus brief updates from Tally and the DAO ecosystem!
Aave Launches v3 Protocol on 6 L2 and L1 Chains, with Ethereum Mainnet Planned
TL;DR: The new version of the protocol includes several features to improve capital efficiency and reduce insolvency risk.
Aave’s newly released v3 offers some key improvements that address the most pressing drawbacks of the pooled liquidity lending model. Initially pioneered by Compound and then adopted by EthLend (precursor to the Aave protocol), this sort of lending protocol allows borrowers and lenders to interact through shared liquidity pools. This significantly reduces friction involved in matching individual lenders and borrowers (as was the case in the original EthLend protocol from 2017), and the framework has become the standard for lending projects across defi in the years since initial introduction. Currently, forks of the Aave and Compound lending protocols have nearly $10 billion in combined value locked within their smart contracts.
Source: DefiLlama Compound and Aave fork dashboards
While these mechanisms have set the standard for defi lending, they also have some severe drawbacks. Each collateral asset within a lending protocol can interact with all other assets, which creates a risk of total market collapse if a single asset experiences a sharp enough crash.
Guarding against these black swan risks has required very conservative risk parameters. One example is the widespread reluctance to allow Tether USDT to serve as collateral within these markets. Despite being the most widely used and liquid stablecoin, Tether’s dubious reserve backing and potential for crashes has forced Aave and Compound to keep their distance. And even for assets that are generally considered high quality (such as Centre’s USDC stablecoin), the maximum permitted leverage must be set based on the highest potential volatility between any other borrowable assets, which constrains capital efficiency. So for a user wishing to use USDC as collateral to borrow another USD stablecoin, they face the same maximum leverage levels of between 4-5x that they would have borrowing a volatile crypto asset such as Ether.
Initially, protocols like Aave and Rari Capital’s Fuse addressed these risks by creating isolated lending markets. Splitting different assets into independent groupings allowed for creating markets to serve high risk assets (such as Rari’s OlympusDAO pool), as well as increased leverage for pools that included only low volatility assets or tokens referencing the same underlying asset (eg. Rari’s stable asset pool). But this came with the tradeoff of fragmenting liquidity, which reduces utility for both borrowers and lenders through lower capacity and greater interest rate volatility.
Aave’s v3 protocol includes two show-stopping features that help address the key risks of pooled money markets while maintaining a unified liquidity pool that prevents fragmentation.
Isolation mode allows for safely lending against high risk collateral assets (such as Tether and other less transparent stablecoins). An overall debt ceiling is applied to each high risk collateral asset, limiting the maximum losses to the market in a black swan event. And while users can only use a single high risk asset as collateral while in isolation mode, eliminating the convenience of cross margining with their other assets, they can still borrow from the entire market’s liquidity so no longer face the fragmentation and low liquidity of isolated lending markets like Fuse.
Efficiency mode offers another benefit, allowing assets that all reference the same or highly correlated underlying (for example USD stablecoins, or ETH and liquid staked ETH tokens) to be borrowed with much higher leverage. Aave’s new v3 markets have efficiency mode enabled for stablecoins, allowing for up to 30x leverage when supplying one stablecoin to borrow another. This should lead to greater correlation between stablecoin rates, and better utilization of stablecoin liquidity even among the less widely adopted tokens such as GUSD, USDP and TUSD (three of the most prominent small cap USD stablecoins). And in the future as liquid staking derivatives such as stETH gain greater adoption and liquidity, efficiency mode will enable yield strategies that should drive borrowing demand and pull up the yield of Ether and other unstaked native assets.
Both of these features are now available on a series of non-mainnet environments, including the two most prominent Ethereum rollups Optimism and Arbitrum.
With the community’s earlier decision to release v3 under a business source license (source code is available but can’t be used by competitors for up to 3 years), Aave now has a significant runway to build protocol adoption and liquidity network effects. Competitors including Rari and Compound may find it difficult to compete without the benefits of shared liquidity and granular risk controls found in Aave v3, but this could also serve as a forcing function for lenders to release new features of their own. It’s still early in the year, but Aave’s v3 release is already a strong contender for the most impactful defi innovation of 2022.
Sushiswap Releases Trident AMM Protocol on Polygon
TL;DR: After facing long delays, Sushiswap’s Trident AMM should give the project a much needed boost and introduce greater competition into the decentralized exchange landscape.
When it was originally announced last summer, Sushiswap’s Trident exchange protocol gained significant attention and was lauded as a serious competitor to Uniswap v3. But this excitement dissipated quickly, with collapsing price of the SUSHI token, several high profile departures from the core team, and an unsuccessful takeover bid from the Arca hedge fund and Abracadabra stablecoin project all causing upheaval. As recently as this month, many were wondering if the project would even ship at all.
The Sushi team has allayed these concerns with a preview launch of their AMM framework on Polygon. Initially, this deployment will only support an upgraded and standardized version of the classic Uniswap v2 style liquidity pool; two assets per pool each weighted with 50% of liquidity, and the traditional X*Y=K formula for determining swap pricing. But over time, Sushiswap plans to add at least 3 additional pool types: concentrated liquidity (similar to Uniswap v3), stableswaps (similar to Curve), and index pools (similar to Balancer).
With all pool types linked under a single contract interface and UI, Sushiswap should be able to offer a strong value proposition for integrators, liquidity providers, and DAOs, while also reducing lead time required for the developers to spin up new pool types in the future. So while trident is shipping months later than expected, it should still give Sushiswap an important boost in the heavily saturated DEX industry.
In Brief:
Tally Updates
Check out our new and improved proposal creation tool, now accessible from the withtally.com homepage!
Ethereum Ecosystem
Gnosis chain (formerly xDAI) based Agave lending protocol faces hack due to non-standard implementation of bridged tokens:
Dydx team releases model for DAO controlled trust entities that can interact with traditional legal systems:
Metagovernance focused Paladin protocol holds liquidity bootstrapping pool:
Cosmos Ecosystem
Juno community passes proposal 16, indicating desire to confiscate funds from “Juno Whale” centralized fund custodian (but without code implementation):
Juno Whale organization presents their arguments against confiscation:
Developers from Juno community continue working on implementation and clarification of prop 16:
Other Ecosystems
Solana based stablecoin project UXD introduces revision to veToken primitive that gives stakers optional exit liquidity:
Thanks for joining us for Tally Newsletter issue 67. Be sure to check out the Tally governance app and join us on Discord for the latest updates!
Anything we missed? New developments or protocols you’d like to see covered? Drop us a line at newsletter@withtally.com
Best,
Nate, Tally