How will the merger of the adjacent DeFi leaders be affected and how should you prepare?

This article is from Polygon, original author: Akhil Vajjhala & Jack, compiled by Odaily Planet Daily translator Katie Koo.

With the merger approaching, how will DeFi leaders be affected and how should they prepare?

The merger would significantly change the way Ethereum operates, how green it is, and how it’s narrative. With this hard fork, Ethereum will run on the new consensus mechanism PoS instead of the original PoW. In this article, we’ll cover the important events happening on various DeFi leading governance forums as the merger nears.

Lido Staking

Lido provides liquidity staking for ETH holders who want to earn income by staking ETH2.0, but do not need to hold the 32 ETH required to run a full node to stake their assets. Lido lowers the threshold for staking ETH and provides stETH (a liquid derivative of staking ETH), which is convenient for users to use in other DeFi protocols.

Lido is one of the most important components when we discuss Ethereum mergers. It involves the process of liquid staking, and Lido plays an important role when it comes to the impact of a merger on ETH stakers in PoS.

Lido protocol upgrade to reset emerging rewards after Ethereum merge, enabling multiple rewards.

With the merger approaching, how will DeFi leaders be affected and how should they prepare?

On-chain portion of post-merger reward distribution

This proposal proposes to redistribute all collected execution layer rewards while generating only protocol fee (0%) stETH as part of the Beacon chain reward distribution run. But no protocol fees are charged/distributed for non-profit Lido oracle reports.

The distribution mechanism is as follows:

  • Node operators collect ETH-specified execution-level rewards on dedicated treasury contracts. Precisely, MEV rewards can be earned in such treasury contracts.
  • The Lido contract withdraws all collected rewards from the treasury, re-stakes them, and mint new stETH for only the protocol fee (10%) as part of the beacon chain (or consensus layer) reward distribution run.
  • In the case of a non-profit Lido oracle report, no new stETH (ie protocol fee) will be mint.
  • The proposal will bring multiple returns, fast transaction times due to minimal impact on existing distribution schemes. It is also quite automated and autonomous. Finally, in the event of a merge hard fork delay, it will fall back to the already adopted solution.

With the merger approaching, how will DeFi leaders be affected and how should they prepare?

Main goal: To measure whether any clients consistently generate more block proposer rewards.

Airdrop forked tokens and maintenance pegs: If any ETH PoW is airdropped to ETH stakers, it will be returned to potential holders of stETH.

AAVE Lending

AAVE is a decentralized lending market, and the lending yield is based on utilization (borrowed amount/deposited amount).

Taking advantage of your position and accumulating more ETH seems to be the choice for most crypto investors considering the merger is the perfect opportunity for a PoW airdrop or just hoping that the merger has not yet priced in.

However, there are many problems with this:

  • If there are any merger related issues > ETH price falls – > mass liquidation occurs.
  • Aave lends user collateral > Merge issues > Both Aave and users are severely affected.

Aave’s borrowing limits were lowered and fees increased until ETH borrowing was completely suspended until the merger was completed.

Aave’s technical analysis affected by the Ethereum PoS merger:

  • It is claimed that the merger should not affect AAVE’s systems.
  • Block Structure: Not affected.
  • Blocking time: Only Aave governance is slightly affected (voting time).
  • Smart Contracts: Aave is not affected.
  • On-chain randomness source: unaffected.
  • New concept of safe head and final blocks (potential changes to Ethereum finality): Aave may be slightly affected, but not smart contracts.
  • Chainlink’s stance will align with PoS chains. Chainlink will not be integrated into the Ethereum PoW fork, it will be fully committed to the PoS chain, which ensures that there are no issues with oracles and data.

AAVE ETH PoW Fork Risk Mitigation Plan:

With the exception of ETH, most tokens are probably worthless on the ETH PoW chain. Therefore, a strategy that users might employ to maximize their crypto holdings might be to borrow as much ETH as possible (mostly secured by stablecoins or other tokens).

Also, the flow from stETH holders to ETH should be observed as stETH may not be worth much on the ETH PoW chain.

Speculative strategies related to PoS mergers and potential ETH PoW forks could have implications for Aave, especially since Aave allows ETH to be borrowed from stETH. stETH being used to stake and borrow ETH on Aave has become a popular strategy and has boosted ETH market utilization to a level of 62%.

Speculators are taking advantage of the risks associated with the ETH market:

  • High utilization of ETH may make liquidation more difficult or impossible.
  • With the ETH market being heavily utilized, the market starts to experience high volatility due to the consolidation event and may not be able to liquidate regular ETH long/stablecoin short positions.
  • This is due to the fact that liquidators will not be able to obtain ETH as collateral as most of the ETH will be borrowed.
  • This in turn may cause some positions to become uncollateralized.
  • High ETH utilization increases the ETH rate to a level where APY for the ETH/th bit is negative.
  • High ETH utilization increases the ETH rate to a level where ETH/ETH positions generate negative APY.
  • Once the ETH lending rate reaches 5%, which happens shortly after 70% utilization (we are now at 63%), the stETH/ETH position starts to become unprofitable.
  • Currently, borrowers on Aave are not using maximum leverage due to devaluation risk. Therefore, it is possible that some positions will have a negative APY earlier. This will cause users to close their positions until the ETH lending rate returns to a stable level, allowing APY to level off.
  • This means that we will see massive redemptions of stETH to ETH, which in turn will push the price of stETH down. As regular stETH holders turn to ETH for the benefits of ETH PoW work.
  • Already high ETH utilization caused regular ETH suppliers to start withdrawing their ETH.
  • Due to the uncertainties and risks associated with ETH PoW forks (often PoS mergers, especially ETH usage on Aave), current liquidity providers may become increasingly concerned about their ETH on Aave, which in turn may Withdraw ETH from the supply side.
  • The increase in utilization has nothing to do with ETH borrowers.
  • Additionally, if the ETH price falls, ETH long/stablecoin short positions may need to be deleveraged by selling the ETH supply.
  • This is why ETH borrowing is frozen.

Alternative: Increase the variable borrowing APR from 103% to 1000% at 100% utilization.

AAVE DAO stance on the ETH PoW fork:

  • Aave’s Request for Comment (ARC) on Aave’s governance requires the Aave DAO to commit to choosing to run the Ethereum mainnet under a proof-of-stake consensus, rather than any fork of Ethereum running an alternative consensus such as proof-of-work.
  • ARC will officially say that the Aave DAO deployment will be on Ethereum PoS only.
  • Authorizes community guardians to take necessary actions to shut down Aave deployments on any forks resulting from the Ethereum Paris hard fork (merge).

AAVE snapshot voting:

  • It is recommended to limit ETH borrowing close to the merger.

Compound Lending

The Compound lending market is very similar to AAVE, but with fewer assets available for borrowing. It only exists in Ethereum, and AAVE has gone multi-chain.

Adjust the ETH interest rate model:

Updated the cETH rate model to a new jump rate model with the following parameters:

  • Ratio at 0% utilization: 2%
  • Best utilization (inflection point): 80%
  • Optimum utilization: 20%
  • 100% Utilization: 1000%
  • Set a borrowing limit of 100,000 ETH for the cETH market.

Bancor DEX

Bancor is a decentralized exchange that allows users to trade between tokens. Its unique value proposition is the ability to provide liquidity to DEXs through its native BNT token without facing temporary losses, however, users do face temporary losses due to poor performance in the recent bear market, an ability that has recently been compromised. attacked.

Proposal: Determine the actions of the Bancor Governance Forum at the time of the fork:

  • Bancor contracts are recommended to be disabled on all PoW forks.
  • Disable Contracts: This option will include disabling all Bancor platform features on the Ethereum fork. There should be little risk in this choice. The main argument for this is that most tokens on a proof-of-work fork will quickly become worthless, which will result in the Bancor platform being drained of any value that can be extracted on the forked chain.

No Action: In the event of an Ethereum fork, no action is taken. This does not pose any risk to Bancor on the Ethereum mainnet, however, any value that may have been extracted from the Ethereum fork would be lost quickly.

Synthetix Derivatives

  • Synthetix will suspend all Synthetix contracts on Ethereum and Optimism approximately 3 hours before the expected merge block, and resume activity after ensuring that Chainlink information flow and other parts of the protocol are stable.
  • SNX tokens will still be tradable, but all other parts of the protocol such as synthetic exchanges, futures, loans, staking (claims, mint, burn) and cross-chain bridges will be suspended. Once the suspension is complete, communications will be made through all channels and all agreement partners will be notified.

Frax is stable

FRAX stablecoins can only be redeemed on ETH PoS :

  • Sam Kazemian (the founder of FRAX) submitted a proposal requiring the project’s stablecoin to be redeemable only on the Ethereum Proof of Stake (PoS) mainnet.
  • FRAX will reject any Ethereum PoW fork.
  • While this is a step towards the future of Ethereum PoS, it may cause FUD among Ethereum PoW users.

MakerDAO Stablecoin & Lending

Overview of Risks and Market Implications – Concessions and Negative Funding:

  • Spot holdings of ETH will receive any PoW fork tokens, while exposure to ETH quarterly futures or perpetual contracts will not. Assuming the market is efficient, this means that quarterly futures after the expected merger date should start trading at an additional discount based on the expected value of the PoW fork token.
  • Recently, we saw the December 2022 quarterly forecast report shift from premium to backwardation, reflecting the possibility of a PoW fork accumulating some “sellable value.” In practice, market participants can buy spot ETH and then sell an equal amount of ETH futures, staking fork value while maintaining delta neutrality. As the expected date of the merger gets closer, we may see some similar activity on perpetual contracts, with deep discounts and negative funding reflecting the expected value of the PoW fork ETH.
  • Implications for Maker: Declining nominal leverage costs (excluding potential fork value) through futures contracts, creating competitive pressure with Maker’s treasury. Users who believe the implied value of a market fork is too high are incentivized to leverage on futures, while those who believe the implied value is lower may prefer to use the Maker treasury (where the treasury owner will still receive any potential forked tokens) leveraged.
  • Response: Maintain competitive rates and avoid losing too much volume to futures contracts.

stETH drops in value:

  • stETH and other liquid collateral assets are likely to become worthless on any PoW Ethereum fork.
  • Therefore, based on the expected value of ETH forked by PoW, the market price of liquid collateral assets may fall.
  • Reaction: Monitor stETH liquidity and respond to parameter changes if necessary (increase stability fee or liquidation ratio); monitor competing rates across DeFi lending protocols using ETH collateral.

External asset fork options:

  • Ethereum hosts a wide variety of externally backed assets. Including cross-chain bridges, centralized stablecoins, and real-world assets. Because these assets are backed by external collateral (either held off-chain or on another chain), they can only be fully pledged on a single chain at a time, and issuers typically need to stake one chain during a fork A chain identified as a canonical.
  • The merged upgrade has strong support among the Ethereum community, DeFi users, and the protocol, which should help ensure that the fork choice consistently supports mainnet (PoS) Ethereum. However, PoW forks may be acknowledged to some extent by one or more external asset issuers due to financial exposure to miners or for other reasons. This could render the underlying assets connected to mainnet Ethereum worthless.
  • Tether in particular is considered a potential risk due to its potential financial ties to miners.
  • Impact on Maker: If all externally backed asset issuers support the merge upgrade, the impact is minimal; if one or more issuers support PoW forks, this may affect DEX liquidity pools and those who accept the asset as collateral Other agreements have a significant impact.
  • Reaction: Confirmation of combined support for key external asset providers interacting with the Maker Protocol, including: Circle, Paxos, Binance, Bitgo, Gemini, Centrifuge issuers, other RWA (real-world asset) issuers, and those connecting DAI to other chains Serve. such as Wormhole, Axelar, Gravity Bridge and Multichain).

Liquidity Pool Protocol:

  • Maker does not provide users with collateral to lend, as many other lending protocols (including Aave, Compound, and Euler) do. Immediately after a PoW fork, a significant subset of assets on the forked chain, including stablecoins and cross-chain bridge assets, will become worthless. This can lead to a centralized lending market that becomes insolvent and incentivizes users to borrow all available ETH in the market (as the asset most likely to retain some value in the fork).
  • The withdrawal of ETH from liquidity protocols (specifically Aave and Euler) could cause ETH borrowing costs to skyrocket, which would put pressure on leveraged stETH positions and potentially impact price parity with ETH.
  • Impact on Maker: Some users may migrate from external lending protocols to Maker treasuries; ETH may be withdrawn from lending protocols, putting pressure on stETH; Decentralized exchange liquidity for ETH pairs before and after the merger may decrease.
  • React: Monitor user behavior and maintain competitive rates to facilitate any potential migration or user acquisition; monitor stETH leveraged positions and ETH lending utilization on Aave, Euler; monitor FX liquidity and consider parameter changes if necessary.

Oracle (Oracle) network and index:

  • Other oracle networks such as Maker and Chainlink are planning to support the merger and consider mainnet Ethereum as the canonical chain. However, the possibility of PoW forks complicates the issue a bit, increasing the chance of erroneous data due to potential centralized exchange issues or code conflicts.
  • Impact on Maker: Increased likelihood of bad/unusual data being sent to oracle feeds; potential for market disruption due to bad price data contained in third-party oracles or preparedness indices.
  • Response: Confirm centralized trading plan, including PoW fork list, quotes, and API changes; encourage industry participants to adopt alternative quotes for any PoW fork, avoid conflicts, and ensure continuity of mainnet Ethereum data.

Network Downtime:

  • This merger is arguably the largest upgrade in Ethereum history. With this major protocol change, there is an increased risk of technical failures that could result in activity failures and unavailability. If Ethereum falls for a period of time, DeFi protocols like Maker could experience price gaps (discontinuous price drops) in collateral assets, which could push vaults into liquidation or even bankruptcy.
  • Implications for Maker: Increased risk of outages and activity failures before and after PoS mergers; potential negative spreads during any network downtime; reduced ability for users to deleverage or protect their treasury locations.
  • Response: Consider changing parameters to increase the safety margin of treasury positions (such as increasing the liquidation ratio, increasing the stability fee for high-leverage treasury types); encourage users to increase the safety margin of their positions before merging and upgrading.

Replay Attacks:

  • Replay attacks allow transactions or messages signed on one chain to be “replayed” on another chain under certain circumstances. Ethereum users (or even custodians or infrastructure providers) can fall victim to so-called “replay attacks” following a PoW Ethereum fork.
  • While EIP-155 provides a simple protection against transaction replay by adding the Chain ID as a transaction signature parameter, there is no guarantee that a PoW fork will adopt a different Chain ID (Chain-ID 1) than the Ethereum mainnet.
  • Impact on Maker: Increased possibility of unanticipated transactions on mainnet, replays from PoW fork chains (such as closing treasury positions, selling forked DAI or forked MKR tokens, etc.); possibility of mainnet transactions, including Maker oracle and keeper operations are replayed to the PoW fork chain.
  • Response: Share information about the risk of replay attacks within the Maker community; advocate for PoW forks to use alternative Chain IDs (rather than Chain-ID 1 that mainnet Ethereum will continue to use) to avoid replay transactions.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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