Firstly, we are so thankful for the analysis and proposal.
While we are aware that you already posted the proposal in the Curve governance forum, we’d love to share our view on this.
Basically, this parameter change will significantly increase the liquidity in normal times and reduce LPs’ IL risk. We basically agree with this approach, and there’s nothing against it in us.
However, there are some concerns about the impact on price discovery during mass slashing. While this isn’t the main focus of the proposal and its related research, let us share some thoughts, after sharing why we think that matters.
Why we care about mass-slashing
Regarding Wormhole’s comments, as already answered by Steakhouse, we basically disagree.
However, there is one important point to note, which is that stETH is the largest source of deposits for EigenLayer. As of March 7th, stETH deposits amount to $3.62 billion, representing over 63% of the total AuM of $5.7 billion. (Ref: https://dune.com/queries/2770927/4633489)
Of course, Lido is not directly responsible for the security of EigenLayer itself or AVS on it; it falls within the realm of their responsibility to design it appropriately.
It is inevitable that the security of the entire AVS would be significantly compromised by a mass-slashing event, although EigenLayer is not designed like lending protocols with liquidation mechanism.
As Lido, and as the largest LST issuer, it is important to make responsible decisions in this regard as Lido continues to grow.
While understanding and expressing maximum gratitude for their efforts to prevent mass-slashing, I believe it is necessary to thoroughly consider the design of appropriate responses and price recovery mechanisms in the event of mass-slashing.
The following is a brief overview and possible direction for this issue based on our quick research. The purpose is not to seek approval for these opinions, but to share awareness of the issue and receive feedback from the community.
Price discovery and price recovery in case of “black swan” events
In the proposal, it is mentioned (if our understanding is correct) that the thickening of the Curve pool’s liquidity may contribute to the recovery to the equilibrium price, including the risk premium, after a black swan event such as mass-slashing happens.
Regarding this, while there is no clear refutable evidence, based on an understanding of the nature and differences of each DeFi AMM, We are considering the following. For clarity, I have included a paper that we find it to be useful during our research.
In conclusion, while Curve is effective in normal price equilibrium, it is unlikely to contribute to the discovery of the equilibrium price with a risk premium in the event of a crisis, including a black swan event.
Of course, while some LPs may continue to provide liquidity without concern after the price collapse of stETH, many LPs are expected to withdraw liquidity at a dramatic speed due to fear of IL.
In such a situation, market makers would need to widen spreads in order to provide liquidity in order-book trading, and LPs in AMMs will suffer from IL if they don’t actively manage their position. Uniswap v2 and Uniswap v3 are clear examples, especially Uniswap v3, where LPs can move their liquidity to another pool with a different fee tier, potentially covering massive IL.
As for the price discovery itself, Constant-product AMM may be able to contribute to more passive price discovery.
Therefore, if we are considering preparing for events such as black swan events, it seems more appropriate to consider incentives for providing liquidity to Uniswap v3, for example. Whether this should be temporary or permanent is still unclear, so we will not delve into that at this point.
These are not conclusions derived from thorough research, but ideas proposed in discussions within the team and Alphaist, our friend who is deeply involved in research on LVR.
Additionally, while the introduction of liquidity incentives, as well as the introduction of something like AAVE’s safety module, have been discussed in the forum several times, all have been opposed. The reason is also mentioned here, as it seems that such modules are not working well. This is similar to the minting of DAI through the purchase and burn of Maker DAO’s MKR token. One reason is that the supply and demand of AAVE (MKR) tokens are circulating, making it easy for drastic price drops to occur in the event of a crisis.
Therefore, we currently understand that issuing bonds as Lido DAO, or setting up insurance and options, can be more effective.
Conclusion
First, we agree with the proposed change in the Curve’s parameters.
Furthermore, while we have doubts about the effectiveness of this proposal as a preparation for mass-slashing, we strongly feel the importance of such preparations for mass-slashing.
While mass-slashing is outside the main scope of the original proposal, we think it would be worthwhile to discuss this further in various places. This is because stETH is becoming a part of what could be considered “too big to fail”.