Euler Finance founder: Before the merger of Ethereum, should we borrow ETH?
Compilation of the original text: Dongxun
Compilation of the original text: Dongxun
If you borrowed ETH before the merge, you might want to read this article. In the next few days, we can see more clearly what preparations are being made by the DAO and its impact on lenders and borrowers.
The three largest lending protocols on Ethereum are all moving in different directions right now:
Compound Finance proposes to increase the maximum interest rate
Aave is suspending borrowing
Euler Finance proposes to do nothing
If you are an ETH lender or borrower right now, pay close attention. Interest rates and utilization of these agreements may vary significantly over the next few days, which may affect your profit and loss (P&L, or loss and gain, also known as financial results). Let's see how traders affect the lending market.
Merge transactions on lending protocols are pretty straightforward: people borrow ETH in order to get "free" $powETH from the PoW fork immediately after the merge.
Of course, nothing in this world is "free". Borrowing ETH costs you ETH. How much you pay in interest depends on when you start borrowing, and the variable rate you pay every moment.
However, some people are very excited about this transaction, and it has now driven up the ETH lending rate, especially on Aave, which prompted Aave to take action: in order to prevent withdrawal problems, liquidation problems, and prevent the profitability of leveraged pledges from further increasing The Aave community has voted to suspend further lending in an attempt to prevent utilization from rising again.
proposalproposal, increasing the maximum borrowing rate on ETH to 1000% APY to limit the potential for maximum utilization.
How effective are these proposals? How do they affect traders? Let's explore some very hypothetical scenarios using some simple game theory.
First, note that $powETH is valued at ~3% of ETH's value in the futures market at the time of writing.
We can use this to price the maximum amount of interest a borrower needs to be prepared to pay in order to earn powETH. For every $100 of ETH borrowed, they should pay no more than $3 in total interest in ETH until combined.
So if we are 1 day away from the "merge", there is ETH available to borrow, and the annual interest rate (APY) is less than 1095%, then you might as well borrow that ETH.
You should be prepared to pay "1/365 × 1095% APY" for a 1-day loan, as this equates to a 3% annualized return (earning powETH).
In order to make a profit, you should obviously borrow at a lower interest rate. You should also save borrowing until the last minute if possible to minimize interest rates. But what about front-running? If you're late, utilization won't be 100% and you're missing out?
Yes, but that doesn't mean pre-borrowing is a good strategy.
In fact, if you have pre-borrowed on Compound Finance, Aave, and Euler Finance, there may be bad news here.
The problem is that when you're trying to forecast your borrowing costs, you have to price in latecomers who are likely to increase utilization to 100%, even if only for a short period of time. Why?
Because, if you choose a lending protocol that supports a maximum lending APR of 1000% (eg, according to the Compound governance proposal), then anyone who hasn't borrowed below that rate the day before the merger can make easy money.
So even if you're only paying 5% APR now to protect your position, you're pretty much accounting for "1/365 × 1000% APY ~ 2.7%" annualized borrowing costs on the last trading day before the merger.
Because of this, I bet many people who are borrowing ETH now will pay more interest than they hoped to earn in $powETH when the merger comes.
In contrast, if your lending agreement supports a maximum loan annual interest rate of 100%, then you can "safely" borrow the maximum annual interest rate within nearly 11 days before the merger, and you don't need to pay more than you earn in powETH Get more ETH interest.
Because "11/365 * 100% APY ~ 3%" is annualized. So, even if the interest rate on the lending protocol goes up to 100% APY tomorrow, you'll still be able to break even when the powETH tokens hit your wallet in a week or so.
The possibility of locking in "lucrative" deals early on like this could boost the utilization of such lending protocols in the coming days, long before a merger takes place. Isn't it bad?
Maybe so, but lending protocols don't exist in a vacuum. Since interest rates on such lending protocols (e.g. Euler) are higher than others, new lenders may be tempted to migrate in order to get a higher APY.
In fact, many lenders may be happy to get a higher ETH APY and sacrifice a day or two of withdrawal time instead of holding ETH directly to get powETH.
The latter is, after all, a token of questionable value that may be difficult to dispose of after a merger. Why not lock in some profits by lending ETH directly?
As for the question of whether a moratorium on borrowing would protect lenders, I personally think it is unlikely to do so. That's because a borrowing moratorium doesn't guarantee low utilization, it just creates a one-sided market.
In my opinion, unilateral markets almost never work out well and should generally be avoided, as I said before StETH's "depeg" failure.
Lenders also have good reasons to withdraw their ETH before the merger, just as borrowers borrowed money before the merger. Lenders withdrawing ETH supply has the same impact on utilization as borrowers borrowing ETH.
Why not withdraw your ETH and go claim PowETH and re-deposit ETH shortly after if the utilization is not at 100% by the last day? This way you get all the benefits of speculative lending before the event and earn some powETH.
As a lender, you may also want to exit for many other reasons, perhaps fear of being liquidated on a leveraged collateral position, or the risk of a merged ETH price, or simply seeing high interest rates on another lending agreement.
All in all, regardless of the strategy, borrowing rates seem likely to spike ahead of the merger, and loan agreements could reach 100% utilization. How long it can last may depend on the agreement's top interest rate and whether lending is suspended.
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