Deploy 5 million USDC to backstop cbETH liquidations. This would imply lending the USDC into Euler and taking on debts and assets of liquidated users that are long cbETH.
Abstract
Since the liquidation engine on Euler allows for liquidating users without having to repay debts and to sell collateral and there is a competitive advantage if you as a liquidator hold assets on Euler, this would effectively backstop at least 40mil worth of cbETH. It will also has the potential to generate substantial revenues from the liquidation bonuses.
Motivation and Risks
While post-Shanghai depeg scenarios will be less likely, DEX liquidity on cbETH is still much lower than on Lido’s stETH/ETH. This creates concerns in terms of pricing and potential liquidation cascades.
In theory, 5 mil USDC account can hold $35mil worth of cbETH assets and $26mil worth of ETH assets before getting liquidated.
Given a big chunk of supplied cbETH is minted for $EUL tokens and Euler uses partial liquidations (meaning a small chunk of a user’s positions get taken over by liquidators), supply on cbETH can easily be >$70mil bucks before becoming problematic for Euler’s liquidator account.
Should cbETH temporarily depeg, however, the bot stands to make decent profits from the liquidation bonus and price appreciation should cbETH repeg.
What assets could end up on Euler balance sheet as a result of backstopping? (checking to understand the correct risk).
In the end, Euler would be trading the USDC for (rapidly? if it’s someone getting liquidated) depreciating assets with the hopes that enabling the backstop attracts more cbETH/ETH, right?
Have you guys backtested this a bit? Trying to understand the r/r here.
The liquidator account wouldn’t be trading the USDC for liquidated assets. The Euler Protocol supports a little known liquidation mechanism where the liquidator can just take both the deposits and debts from the liquidated party, along with a bonus. Let’s go through an example.
Suppose Alice is available to be liquidated. She has a $1m cbETH collateral available for liquidation covering $1m WETH liabilities. The liquidator account proposed above (with $5m USDC collateral) would simply take both Alice’s deposits and debts. After liquidation it would have $6m collateral ($5m USDC + $1m cbETH) and $1m liabilities ($1m WETH). Of course, it would also likely have a bonus on top. The desired bonus could be configuered in the liquidation logic. Perhaps the account would step in to grab liquidations with a 5% bonus or more. That means it would make $50k profit in this example.
Note that the liquidator account doesn’t actually end up losing value unless its newly acquired positions continue to deteriorate. In the case of cbETH collateralising a WETH borrow, this wouldn’t be so much of an issue. Positions in this case would be liquidated only in the event that there is a ‘depeg’ between cbETH and WETH. But these kinds of positions can always be held in the short term and unwound later (often very profitably). They are essentially delta neutral. Liquidating positions with cbETH collateral backing e.g. USDC debt are more risky, since they essentially require the liquidator account to take a long position on ETH). However, even these kinds of positions could be closed within a short time e.g. 48 hours after liquidation to protect the value of the account.
The main purpose of the account is to provide a buffer for liquidations during liquidity crunch periods, in which ordinary liquidators cannot simply swap cbETH for WETH/USDC due to a lack of DEX liquidity.
This seems prudent and could really bootstrap the cbETH lending pool when it gets promoted to collateral tier.
The USDC could be put back in the treasury post the Shanghai upgrade (after the dust settles of course)?
Personally I’m not really a fan of cbETH being collateral in the first place, so I guess this is a good precautionary measure.
I’ll take this opportunity to question why cbETH was added as collateral in the first place given how little liquidity it has on the market. It also poses some serious centralization risks and helps promote a ‘CEX’ offered product in DeFi. On the other hand LUSD is barely a cross-tier asset and it has significant more liquidity on the market than cbETH. There’s currently about $80M in LUSD liquidity available globally and it’s an extremely reliable and stable asset. cbETH however, is a fairly new product and not nearly as liquid or trustworthy.
I can’t help but feel like there is too much preferentiality at play with regards to CoinBase issued assets. CoinBase is a reputable company but I would not go to such lengths to enable the presence of their product offerings in DeFi, I don’t see any upside to it personally. In this case I feel like Euler is playing a role in enabling cbETH adoption given that it’s not a highly utilized asset in DeFi atm. The DAO should make careful considerations around the risks of integrating very centralized tokens and should also extend the same sort of preferential treatment to DeFi native permissionless products in the future.
I agree that cbETH liquidity must be higher than now without supply caps.
But the governance has already taken a risk when onboarded low-liquidity collateral. And in the event of a sharp drop in cbETH value (low risk, but still exists), treasury will be left with cbETH instead usdc.
So, I don’t think the concern for liquidity cbETH should be attributed to the use of Euler treasure