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The Tally Newsletter, Issue 68

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The Tally Newsletter, Issue 68

March 25, 2022

monetsupply
Mar 25, 2022
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The Tally Newsletter, Issue 68

newsletter.tally.xyz

Welcome back for issue 68 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:

  • Lido’s Expanding Lead in Ethereum Liquid Staking via Aave Integration

Plus brief updates from Tally and the DAO ecosystem!


Lido Sees Surge in Demand Driven by Aave Collateral Usage

TL;DR: The recent addition of stETH to the Aave money market has enabled leveraged staking strategies that have widened Lido’s lead in total staked Ether.

While Lido has long been a market leader within the Ethereum staking space, recent integrations with the Aave lending market have turbocharged adoption and deposit volumes. This has had the effect of widening Lido’s lead in total Ether staked (even exceeding top centralized exchanges such as Kraken and Coinbase), while also significantly increasing systemic leverage and raising key questions about validator centralization. We dig into the recent market moves and potential impacts below.

Aave listing

stETH was initially added to the Aave v2 protocol on Ethereum mainnet at the end of February. This followed roughly several months of discussion in the Aave governance forum, as well as development work to allow the proposed market to conform with stETH’s non-standard rebasing mechanism. 

Source: Aave governance dashboard

stETH was listed with a 75% liquidation threshold, which was likely optimized to mitigate price risk of users supplying stETH as collateral to borrow stablecoins. But in the following weeks, we’ve begun to see a different preferred trade take prominence: supplying stETH collateral, borrowing ETH (at a lower rate), and then staking the borrowed ETH back into stETH to increase the total yield earned.

Leveraged ETH staking

With maximum permitted borrowing of up to 70% of collateral value, defi users quickly realized they could potentially earn as much as 3x staking rewards by continuously borrowing ETH from Aave and resupplying stETH. While initial usage was limited, over the past week these positions have exploded and total stETH deposits on Aave now total over $1 billion.

Twitter avatar for @LidoFinance
Lido @LidoFinance
stETH reserve size on @AaveAave now exceeds $1 billion 👻🏝️ app.aave.com/reserve-overvi…
Image
12:34 PM ∙ Mar 19, 2022
81Likes16Retweets

There are also several structured products that are competing to capture this market demand, while abstracting away position management and reducing transaction costs required to establish this position. Galleon DAO and Beverage Finance (two micro-cap asset management protocols) were the first to capitalize with their recently launched ETHMAXY leveraged index product (targetting 3.09x leverage of stETH vs ETH). Larger competitor Index Coop is also planning to release a similar product in the near future.

Twitter avatar for @galleondao
Galleon DAO ⚓ $ETHMAXY @galleondao
For all our Ethereum pirates out there @galleondao 🏴‍☠️ and @BeverageFinance 🧃 bring you our first mainnet collab product: ETH Max Yield Index ($ETHMAXY) thread below 👇: blog.galleon.community/the-eth-max-yi…
blog.galleon.communityThe ETH Max Yield Index is Live on Ethereum!If there’s a man among ye, ye’ll come up and fight like the man ye are to be!
1:26 PM ∙ Mar 10, 2022
46Likes26Retweets

This huge inflow has helped push up ETH borrowing and lending rates on Aave, from a previous equilibrium of near 0% to around 2.5% for borrowing and 0.4% for depositing ETH. This has reduced maximum expected returns of leveraged ETH staking positions from as high as 12% at launch to current rates of around 7% (still nearly double the 4% base return offered by Lido).

Source: Aave market dashboard

Changing Aave market dynamics and defi risks

This marked increase in ETH borrowing activity could represent a windfall for the Aave protocol in a few ways. First, Aave captures 10% of all interest paid on ETH borrowing positions via their reserve factor. While this is primarily charged to help cover potential loan losses if underwater positions can’t be effectively liquidated, any excess reserves can be captured by the Aave protocol and used for governance approved initiatives (eg. buybacks, investments, payroll, etc). 

In addition, interest earned on ETH collateral helps offset the cost of borrowing other assets from the protocol, effectively subsidizing usage across the rest of Aave’s markets. With ETH serving as Aave’s most important collateral asset (primarily supporting users borrowing stablecoins), this source of intrinsic yield could help the protocol wean itself off of liquidity incentives without adversely impacting utilization. 

Twitter avatar for @MonetSupply
monetsupply.eth @MonetSupply
aave could remove incentives for supplying ETH (currently 0.11%), borrowing stables (up to 2%), and ETH borrowers would still come out ahead at 50% LTV [(1.6% ETH yield increase - 0.11% ETH incentives) / 50% LTV] - 2% stablecoin borrow incentives = 0.98% reduction in borrow cost
Twitter avatar for @MonetSupply
monetsupply.eth @MonetSupply
ETH supply rates would surge from current ~0.37% (already much higher than previous equilibrium) up to ~2% for a stablecoin borrower targeting 50% LTV, this would effectively reduce their net borrow cost by ~3%+ https://t.co/UbyIYTzKWn
6:57 PM ∙ Mar 18, 2022

However, this tailwind comes with significant tradeoffs. At $1 billion in stETH collateral and growing, Aave is already exposed to potentially fatal levels of systemic risk if Lido were to be compromised via a hack or governance attack. This could cause contagion across Aave’s other markets, as defaulted ETH loans would impact the true value of aETH used as collateral for a large part of Aave’s loan book. And even a less severe loss, such as a moderate slashing even on Lido’s validators, could lead to market dislocation with forced selling of stETH causing its value to fall far below 1:1 parity with ETH.

Source: DAI Stats

As one of the largest depositors in the Aave market via the DAI direct deposit module, Maker would also face systemic levels of risk from this sort of contagion and default playing out (in addition to the $100 million in direct Lido exposure Maker holds through stETH and steCRV collateralized vault types).

Both the benefits and risks of the stETH integration are likely to be accentuated with a new governance proposal pushed forward by the team at Instadapp (which offers Aave leverage integrations through their smart contract wallet infrastructure). The proposal would adjust the ETH borrowing rate curve (which determines borrow rates as a function of utilization, or percent of the market’s assets currently being borrowed), lowering interest rates to support higher efficiency.

Twitter avatar for @The3D_
thΞ3d.eth( 👻, 👻) @The3D_
Strongly in favor of proposal 68 by @Instadapp to optimize the ETH borriw rates and favor the usage of stETH as collateral
app.aave.comAave - Open Source Liquidity ProtocolAave is an Open Source Protocol to create Non-Custodial Liquidity Markets to earn interest on supplying and borrowing assets with a variable or stable interest rate. The protocol is designed for easy integration into your products and services.
7:18 PM ∙ Mar 25, 2022
30Likes9Retweets

Assuming this proposal is adopted and the ETH market reaches equilibrium around the target rate of 70% utilization and 3% borrowing rates:

  • Aave’s annualized revenue from ETH would increase from $1.8 million to $9.1 million (without accounting for a likely increase in total deposits in the ETH market, which would further boost revenue)

  • Aave ETH deposit rate would shoot up from current 0.4% to 1.9%, which would offset up to 3% APR in borrowing costs on a typical position at 50% loan to value ratio

  • Lido could see around 700,000 ETH in inflows into stETH (a 25% increase in their total deposits from current levels)

So while tail risks are considerable and would only grow with this proposal’s adoption, the payoff is also very high for all involved. So far, it seems most AAVE governance participants are keen to see this go through.

Source: Aave governance dashboard

Consensus and base layer centralization risks

While it has been largely absent from the above discussions, Lido’s dominance in liquid staking is beginning to cause concern about Ethereum base layer decentralization and consensus stability. 

Twitter avatar for @RyanBerckmans
Ryan Berckmans - ryanb.eth @RyanBerckmans
1/ Today, Lido's stETH has a 25% share of all staked ETH and 87% of staking derivatives. But also today, staking derivatives are 29% of staked ETH and may grow to 80%+ within two years. Lido is on track to control, say, 50%+ of all staked ETH. imo, it's a real problem 👇
4:23 AM ∙ Mar 22, 2022
444Likes59Retweets

While Lido bills itself as a decentralized liquid staking protocol, it still has several points of weakness. Key parts of the protocol including screening acceptable validators is performed via the Lido DAO, which is in turn controlled by LDO token holders. The LDO token has an extremely concentrated distribution, centered very heavily on founders and seed investors, with participation from additional investors later but relatively low free float on the open market.

The validator set has been widened and continues to expand over time, but currently all of Lido’s ETH stake is distributed across only a few dozen professional validators. Certain competitors, particularly Rocket Pool, support less concentrated validator distributions by allowing permissionless entry into the validator set secured by economic incentives, rather than DAO review and participant reputation. 

As Lido’s market share grows, it may become more difficult for competitors to break in and gain integrations considering stETH’s immense liquidity network effects. While Rocketpool’s struggles are arguably made worse by their refusal to offer any protocol funded liquidity incentives, the Aave lending integration may help stETH separate further from competitors (users can earn nearly 2x returns through leverage, without relying on Lido funded incentives). 

Twitter avatar for @_vshapovalov
Vasiliy Shapovalov @_vshapovalov
I do not think that balanced diversity of liquid staking protocol is a worthy goal to pursue; I think that the right strategy is to push for the best protocol to win and for the winning protocol to be better. We're shaping our strategy around that, at least. 3/
11:57 AM ∙ Mar 22, 2022
19Likes1Retweet

In a market that seems to heavily favor incumbents over challengers, the best strategy for addressing base layer centralization may be focusing on protocol improvements to Lido itself. This also serves as an interesting example of transmission of centralization risk between different layers of the crypto tech stack, with application layer decisions made by DAOs significantly influencing base layer consensus. 


In Brief: 

Tally News

  • Find the Tally governance app and resources under our new domain, tally.xyz!

Twitter avatar for @tallyxyz
Tally @tallyxyz
At Tally, we've been focused on building insanely useful governance tools. We're thrilled about the progress we've made so far! Along the way, we've observed that DAOs need help in more areas than just governance. 👀
3:00 PM ∙ Mar 24, 2022
12Likes2Retweets
Twitter avatar for @tallyxyz
Tally @tallyxyz
We see opportunities to support DAOs on every step of the journey from forming an idea to changing the world, so we've broadened the scope of our mission to include building an ecosystem that helps DAOs launch and scale. 📈
3:00 PM ∙ Mar 24, 2022
Twitter avatar for @tallyxyz
Tally @tallyxyz
To reflect our broader mission, we've moved Tally to new homes on the internet. 🏡 Twitter: @tallyxyz Website: Tally.xyz Come give us a Follow and a visit!
tally.xyzTallyThe homepage for DAOs
3:01 PM ∙ Mar 24, 2022
7Likes1Retweet

Ethereum Ecosystem

  • Bridge protocol Stargate Finance launches, with initial token auction fully purchased by Alameda Research in a single transaction:

Twitter avatar for @AlamedaTrabucco
Sam Trabucco @AlamedaTrabucco
First off: we did indeed buy all the tokens. We love the team and what they're doing, and we believe this space and the technology they're building is really important.
4:28 PM ∙ Mar 22, 2022
500Likes85Retweets
  • Teller begins offering unsecured stablecoin loans to Singapore residents using traditional credit scoring:

Twitter avatar for @useteller
Teller @useteller
Today, we’re excited to announce the first market to integrate the Teller Protocol and offer unsecured DeFi lending - SG.Loans! Read More ⬇ medium.com/teller-finance… [1/4]
medium.comTeller Debuts Unsecured Lending to Singaporean DeFi Consumers with SG LoansSG Loans, a Singapore-based decentralized and unsecured lending market built on the Teller protocol via Polygon and in partnership with…
4:03 PM ∙ Mar 24, 2022
78Likes22Retweets
  • MakerDAO receives collateral application from US based bank:

Twitter avatar for @MakerDAO
Maker @MakerDAO
Huntingdon Valley Bank, a Pennsylvania Chartered Bank founded in 1871, has submitted a Collateral Onboarding Application to MakerDAO. If approved by Governance, it will be the first collateral integration from a US-based bank into the DeFi ecosystem.
forum.makerdao.comMIP6: Huntingdon Valley Bank Loan Syndication Collateral Onboarding ApplicationNote: This is a MIP6 application being submitted by RWA Company LLC (“RWAC”) on behalf of HV Bancorp Inc. (“HVBank”) Authors: Greg Di Prisco (@g_dip) & Max Glass (@maxglass) of RWAC, with Dan Krewson & Hugh Connelly of HVBank DISCLAIMER The content of this communication is for informational purpo…
6:14 PM ∙ Mar 25, 2022
121Likes34Retweets

Cosmos Ecosystem

  • Juno core team members and community rally around compromise proposal, removing Juno whale’s voting power while negotiations continue:

Twitter avatar for @wolfcontract
Wølfcontract @wolfcontract
This solution i will back. Community wins. Developers win. Validators win. Juno wins. #Prop17 (Unity) ✅commonwealth.im/juno/discussio… Please upvote & discuss. PS: Core-1 is back united. $JUNO #Unity
Image
8:22 PM ∙ Mar 21, 2022
603Likes127Retweets
  • Junowhale rejects community compromise proposal, suggesting to maintain status quo where they continue to hold governance power and earn staking rewards:

Twitter avatar for @takumiasano_jp
Takumi Asano (朝野巧己)| GAME ⚛️ | Juno Whale @takumiasano_jp
Whale Drop Compromise
commonwealth.imWhale Drop Compromise## TL;DR - Half of $JUNO held by Juno Whale, including the staking reward, will be distributed equally to addresses holding at least 10 $JUNO based on the snapshot at the end of the Prop 16 voting period (block height: 2293382) and the other half to our clients - With the community’s Burn option and…
8:10 AM ∙ Mar 24, 2022
371Likes68Retweets

Other Ecos

  • Solana based stablecoin project Cash is exploited, with hacker’s return of funds for all users with <$100,000 balance creating difficult conundrum for project maintainers:

Twitter avatar for @CashioApp
Cashio ($CASH) 💵 @CashioApp
Please do not mint any CASH. There is an infinite mint glitch. We are investigating the issue and we believe we have found the root cause. Please withdraw your funds from pools. We will publish a postmortem ASAP.
9:59 AM ∙ Mar 23, 2022
434Likes219Retweets
Twitter avatar for @ceterispar1bus
ceteris @ceterispar1bus
cashio gets exploited. hacker sends money back to accounts with <$100k. hacker also sends money to sunny (yield aggregator) for positions held by accounts <$100k. sunny now holds all these funds. is sunny responsible for distributing funds as per hacker's intentions?
11:18 AM ∙ Mar 25, 2022
13Likes2Retweets
  • Georgetown professor offers framework for crypto-native disclosures:

Twitter avatar for @ChrisBrummerDr
Chris Brummer @ChrisBrummerDr
I’m thrilled to release a white paper offering the first crypto-native disclosure system for DeFi--and a range of new infrastructures capable of exciting developers and regulators: Disclosure NFTs, Disclosure DAOs, and Disclosure DIDs.
chrisbrummer.medium.comIntroducing Disclosure NFTs, Disclosure DAOs, and Disclosure DIDsBuilding a sustainable DeFi firm or protocol, or for that matter any technology company, will increasingly involve a merger of…
7:32 PM ∙ Mar 24, 2022
538Likes132Retweets

Thanks for joining us for Tally Newsletter issue 68. 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@tally.xyz 

Best,

Nate, Tally

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