Risk-Reduction Strategies: DeFi Giants Aave, Compound Freeze Markets, and Cap Loans

On the Ethereum network, Aave implemented a plan to freeze the markets for 17 different assets, including Yearn.Finance (YFI), Curve DAO (CRV), Gemini Dollar (GUSD), Maker (MKR), and 1inch (1INCH) tokens, on Sunday.

According to DeFi Llama, the two crypto lending protocols Aave and Compound are responsible for $3.7 billion and $1.7 billion, respectively, of the entire wealth locked in the DeFi ecosystem.

According to Aave founder and CEO Stani Kulechov, “DeFi protocols are being put to the test and it highlights how communities can implement new parameters to enhance risk mitigation factors in volatile market environments that are moving quickly.” “It’s been interesting to see the DeFi community debate, suggest, vote on, and adopt new parameters to adapt and secure the protocol with such remarkable openness.
Despite the timing, neither proposal is in response to the most recent news to shake up the markets: BlockFi declaring bankruptcy on Monday, following weeks of speculation that it would after FTX’s collapse at the beginning of November.

Avraham Eisenberg, the trader in charge of the Mango Market breach in October, recently took out a loan on Aave for 40 million CRV tokens. He looked to be preparing to sell the tokens, which would have destroyed the value of CRV and given him the opportunity to profit greatly from short bets, which are derivative contracts that let traders wager against the value of an asset.

That isn’t just conjecture; Eisenberg revealed his strategy on Twitter in October.

Aave’s financial modeling platform, Gauntlet, suggested certain modifications to the protocol to better safeguard it: “The effort to squeeze CRV on Aave has been ineffective and unprofitable.
Members of the Compound DAO also unanimously voted to set borrow caps for 10 tokens, including its implementations of Wrapped Bitcoin (cWBTC2), Uniswap (cUNI), Chainlink (cLINK), and Aave.

According to Paul J. Lei, a protocol program manager at Gauntlet, “Aave V2 lacks many of the risk controls that Aave V3 solves for (supply caps, borrow caps, isolation mode, e-mode, etc.).”
Aave V3 was released in March on the Fantom, Avalanche, and Harmony networks as well as Arbitrum, Optimism, and Polygon Layer 2 scaling solutions. It is an updated version of its V2 lending protocol with increased security and cross-chain features.

Simply put, the borrow limitations granted by Compound still permit individuals to borrow the assets. According to him, only a very small percentage of protocol activity will be impacted by the borrowing cap for non-stablecoin assets because the vast majority of borrowing on Compound—more than 96%—is done in stablecoins.

Market risk and volatility have so far been constant over the past month.

Lending rates for GUSD increased by as much as 73% on November 16 after the cryptocurrency exchange warned that withdrawals from its Earn product may be delayed after Genesis, which manages the product, abruptly stopped accepting withdrawals.

Another possibility is that GUSD holders rushed to exchange their tokens for alternative assets out of concern that Gemini might not be able to honor redemption requests.

Although the exchange tweeted that it was still working with Genesis to resume withdrawals for its Gemini Earn product, Gemini has not yet collapsed. DeFi Llama reports that Gemini has honored GUSD redemptions totaling more than $200 million since the company stopped allowing Earn withdrawals. Given that GUSD currently has a market capitalization of $601 million, the decrease in circulation is significant.