AaveDAO debates Dai guarantee limit after $600M mint in eUSD backing.

Aave Decentralized Autonomous Organization (AaveDAO) continued to debate limits on Dai (DAI) securities on April 5, as risk management consultants Chaos Labs presented a new proposal to reduce DAI's loan-to-value ratio (LTV) by 12 percent. Previously, Mark Zeller, the founder of the Ave Chan initiative, argued for a 75% discount.

Aave is a crypto lending platform powered by multiple blockchain networks. It allows borrowers to take out a loan in one cryptocurrency while putting another as collateral. It is managed by Aave token holders who jointly established AaveDAO. Die is an algorithmic stable coin backed by several types of crypto securities, including USDC (USDC), Ethereum (ETH), and more. Die is issued by Maker Protocol, which is managed by MakerDAO.

MakerDAO has been criticized on the AaveDAO forums after issuing 600 million DAI and depositing it in a vault with the decentralized credit protocol Morpho. An April 1 proposal on the MakerDAO forums sought to increase the Vault operating limit to 1 billion DAI, potentially bringing more supply to the stablecoin.

MakerDAO says it will lend its newly minted die stable coin to end users who deposit eUSD to the Morpho protocol. So they say the new coins are properly backed by a stable case. In response, critics say eUSD is a risky asset and MakerDAO is being overly aggressive in using it for collateral purposes.

On April 2, Zeller proposed that the Aave LTV for Dai be set to zero instead of the current 75%, which would essentially prevent Dai from using it as collateral for any new Aave loans. Zeller said the change was necessary because of the “natural risk of DAI as a collateral” after “disturbing events”. The proposal is still under discussion and has not been put up for a formal vote.

On April 5, AaveDAO's risk management consultant Chaos Labs analyzed the potential risks of the new vault and suggested a 12 percent LTV reduction instead. This still allows borrowers to use DIE as collateral on new loans, but requires them to maintain a higher collateral-to-loan ratio to offset the increased risk. Currently, die depositors can only borrow 75% of die value. A proposal from Chaos Labs lowers this rate to 63 percent.

Related: Aave Deploys DeFi Protocol on BNB Chain

One of the key issues in the debate is the nature of the stablecoin eUSD issued by the Athena protocol. According to Etena documents, eUSD is backed by two components: an amount of Lido Staked Ether (stETH) that market makers deposit into the protocol, and a corresponding futures short position that hedges the ETH represented by this deposit.

This support, according to the documents, must be “delta neutral” or unable to decrease or increase in value. This is because, if the price of ETH increases, the value of the stETH deposit should increase, while the value of the short position will decrease, resulting in zero profit and loss. On the other hand, the decline in the price of ETH should have the opposite effect, causing a loss in the deposit price, which is equal to the price of the short position. In any case, the value of the eUSD token should remain stable no matter which direction the ETH price goes.

In addition, the documents state that holders can earn profits from eUSD shares, which is said to come from two sources: First, stETH deposits will receive high rewards from the Ethereum network, which can be commanded by eUSD holders. Secondly, the future price of ETH is currently much higher than the spot price, creating a “base” or spread between them, which can be held by stakeholders. According to the official website of the protocol, eUSD stock will pay approximately 37% yield as of April 5.

While this EUSD is said to be independent of Delta, critics say it could be under-guaranteed in two different ways. First, in a crypto bear market, the ETH future price may be lower than the spot ETH price. If this happens, the yield on the spot will turn negative, indicating that stakeholders will have to pay to hold eUSD instead of getting paid for holding it. Critics say this will lead to a wave of redemptions, creating bad debt in the system and driving the value of the eUSD below $1.

In an April 2nd series on X, Yearn.finance founder André Cronje argued that eUSD should be “unsupported” due to its “negative funding rate”:

“Right now things are going well (because the market is positive and funding rates are positive [because everyone is happy being long]), eventually this changes, funding becomes negative, the margin/guarantee ceases, and you have an unfunded asset.

Second, a problem with the Lido staking network may cause the value of stETH to decrease relative to ETH. This could result in collateral support of less than $1 for each eUSD. Decentralized finance educator BowTiedIguana expressed this concern in a response to Cronje's post.

“An issue I have never once seen acknowledged or discussed is that ETH is not a perfect hedge for stETH. If something bad happens on the technology side (low probability but very high impact), the idle queue will be very long and the prices of the two assets will differ significantly.

On April 3, developers of the Etna protocol held a public discussion on X with MakerDAO founder Rune Christensen and Morpho development team CEO Paul Frambot from Zeller and Awe Chan.

In the discussion, Zeller argued that MakerDAO and Morpho don't have enough protection to protect them from exposure. The rest of the participants said that eUSD poses some risk to the Maker protocol, but that the development teams from all three projects (Maker, Ethene, and Morpho) were managing this risk well.

Related: Maker's ‘Endgame' Launches, Aims to Capture 100B DAI Tether

The idea of ​​reducing die LTV on Aave is still under discussion, and no formal real-time vote has yet been created or scheduled.