The Tally Newsletter, Issue 72
June 17, 2022
Welcome back for issue 72 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.
In this issue we cover:
Crypto Market Contagion Driven by Celsius, 3AC and stETH
Fei Protocol’s Hack Compensation Proposal
Plus quick updates from Tally and the DAO ecosystem.
Crypto Contagion Continues with 3AC Blow Up and stETH Volatility
TL;DR: Losses triggered by the Terra collapse are continuing to reverberate through the space, with stETH liquidity and hedge fund Three Arrows Capital becoming the latest focal point of market stress.
Over the past weeks, the crypto markets have faced continued instability and sharp price declines. While there are several contributing factors, growing stresses on Lido’s stETH staking derivative and the unraveling of hedge fund Three Arrows Capital seem to be primary factors driving the market down. This has forced a range of governance responses across top DAOs and defi protocols.
Illiquidity in Lido’s stETH staking derivative is a key driver of the recent market breakdowns, with pressures in turn kicked off by the collapse of Terra UST last month. During the early phases of the Terra crash, key Terra investor Jump Crypto withdrew tens of millions of dollars worth of assets from the primary Curve stETH-ETH liquidity pool and converted proceeds to ETH and then stablecoins to help support the UST peg.
Source: Coingecko
In addition to forcing price down below parity with ETH, this also contributed to growing illiquidity in the stETH market. Curve concentrates liquidity for stable assets around a 1 to 1 ratio, which reduces slippage in normal conditions but has the negative effect of reducing available liquidity as price slips farther away from parity. Combined with the removal of liquidity, this had the effect of significantly weakening the stETH market and increasing downside volatility.
Even though stETH price recovered to around 0.98 ETH in the aftermath of the Terra collapse, lower market liquidity significantly increased risk of collateralized positions on defi protocols including MakerDAO and Aave. Aave in particular was a driving force in this year’s parabolic ascent of stETH supply, due to a “leveraged staking” strategy where users could borrow ETH at low cost and then invest the proceeds into stETH to capture the spread. The figure below shows how stETH in circulation more than doubled in the months following Aave’s vote to accept stETH as collateral.
Source: Coingecko
Retail focused lending platform Celsius and hedge fund Three Arrows Capital were caught on the wrong side of the stETH trade, having invested significant sums into the asset which they were then forced to divest at a loss when they were faced with withdrawal requests and margin calls. This caused contagion to several centralized counterparties across the Crypto space including Genesis (prominent lending desk and prime broker), Derebit (options exchange), and Blockfi (crypto lender). There are also rumors that 3AC may have managed funds on behalf of some of their VC portfolio companies, which could trigger a wave of failures across early stage crypto projects.
Aave also faced growing risks of cascading liquidations on stETH collateral. If stETH price fell enough to trigger some liquidations, the forced selling could potentially create a vicious cycle of further declines and liquidation pressure.
Aave’s risk manager Gauntlet put forth a proposal to disable further ETH borrowing or stETH supplying, as well as raising stETH liquidation ratio to 90% (from current 81% value) to try to reduce risk of this negative feedback loop being triggered. But this would have the effect of increasing losses in the event of a severe stETH price fall, and also provided no protection against positions using stETH collateral to borrow stablecoins or other non-ETH assets. This prospect was made more dangerous by the fact that Celsius held a 100 million DAI borrow position mostly collateralized by stETH.
As a result, MakerDAO took swift action to disable their Direct Deposit Module (D3M) that supplies DAI into Aave. While Aave’s proposal was soundly rejected by voters afterwards, Maker took the position that any high risk proposal on an integrated lending market merits removing liquidity as a precaution. Defi’s inherent transparency has prevented much of the fear and contagion risk that is engulfing centralized crypto platforms, but as protocols become more heavily integrated (for example Maker is planning to implement additional D3Ms to other platforms like Compound), cross-DAO coordination and politics will play a growing role in risk management and user safety.
Fei Reimbursement Vote Moves Through Multistage Governance Process
TL;DR: The reimbursement for the Rari Fuse lending pool hack would put significant pressure on Fei’s balance sheet, and also represents the most pivotal use so far of their objection-based “Nope DAO” voting mechanism.
Fei protocol is currently in the final stages of voting on a proposal to reimburse losses in their $80 million hack from earlier this year. But with the crypto markets in freefall, this has become controversial as it would significantly reduce collateralization for their primary product the FEI stablecoin. The prolonged governance process to reach this point has also faced scrutiny and claims of bait and switch tactics.
Shortly following the hack, the Fei community seemed largely aligned with providing compensation to users. This included an affirmative Snapshot vote to this effect. But in the ensuing weeks FEI collateralization fell and opinions shifted.
The next stage of Fei’s governance process queued the compensation proposal in a governance multisig with TRIBE holders given the option to veto automatic execution via the “Nope DAO”, a specially implemented governor contract. The veto was executed, and while this was primarily intended to force a full on chain vote rather than block the proposal outright, this was widely misconstrued on Twitter and other public forums as a rejection of user compensation.
The proposal is now live for a final on chain vote, but as collateralization has continued to fall it seems a majority of TRIBE delegates are rejecting the current compensation scheme. With voting ending later today and no voters in commanding lead, it remains to be seen if compensation will be fully abandoned, or if an alternative mechanism will be proposed to reimburse victims without jeopardizing FEI stablecoin holders. This episode also laid bare disagreements (or misunderstandings) over the role of Snapshot votes and other “soft commitments” within DAO governance.
In Brief:
Tally News
We hope we’ll see you next Wednesday, June 22, at the DAO NYC conference:
Euler Finance lending protocol launches governance on Tally:
Undercollateralized lending protocol TruFi holds first on-chain votes with Tally:
Ethereum Ecosystem
B Protocol affiliated Risk DAO organization releases bad debt dashboard, showing extent of current insolvencies across Compound based lending protocols:
Lido considers plan for dual LDO and stETH governance of Ethereum liquid staking protocol, intended to reduce governance risk for users:
Lido’s stETH liquid staking token falls as much as 5% below peg, pressured by withdrawals potentially caused by financial stress at CeFi lender Celsius:
Balancer votes against reissuing unrecoverable BAL rewards to Fei Protocol
Other Ecosystems
Twitter founder Jack Dorsey hints at decentralized web platform, “web5”:
Avalanche based Trader Joe exchange faces small exploit on fee disbursement contract, with rival Pangolin later facing similar issue:
Cosmos ecosystem’s Interchain Foundation faces criticism from Notional validator over ATOM delegation program:
Thanks for joining us for Tally Newsletter issue 72. 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