Gauntlet Flags Potential cbETH Liquidation Risk On Aave
Single Large Wallet Holds $40M Leveraged Position
By: Owen Fernau •DeFi News
A large leveraged position using cbETH, Coinbase’s liquid staking token, has risk management firm Gauntlet sounding the alarm.
A well-capitalized trader has borrowed nearly $39M worth of ETH, on Aave, a major lending protocol in DeFi with over $8B in deposits. They used cbETH worth roughly $46M as collateral.
cbETH Supplied on Aave
The trader is using a popular strategy which leverages staking rewards by borrowing against liquid staking tokens – in this case, borrowing ETH against cbETH, and then selling that ETH for more cbETH, which is then redeposited in Aave.
Because of the way the trade works, the trader didn’t need to put up all $46M of cbETH up front — they actually only started with 3,849 ETH ($7.4M) and then looped the position, repeatedly borrowing and selling ETH for more cbETH, which they then posted as collateral for the cycle to continue.
Lei and the Gauntlet team are concerned that if cbETH drops by 9% against ETH, the wealthy wallet stands to be liquidated. That means someone could acquire the cbETH at a discount with the potential to sell it for a near-instant profit. Given the limited amount of cbETH liquidity available on-chain, that sale could push cbETH’s price still lower, liquidating other smaller accounts on Aave with more conservative leverage ratios.
Such a liquidation cascade can have negative effects on Aave, in addition to individual traders. “Under certain scenarios, this can create bad debt for the protocol,” Lei told The Defiant in a follow-up interview.
The concern around the cbETH market on Aave isn’t necessarily a new one, but it is notable. Lending protocols are always balancing their risk factors and collateral assets’ potential to leave the protocol with bad debt. Last November, Lei developed a proposal to add borrowing caps to 10 different assets on Compound, another major lending protocol, amid concerns over market volatility.
The wallet which put on the cbETH-backed trade has also taken out a smaller, but similar, position on Compound.
Staked ETH Withdrawals
Ethereum is expected to undergo two upgrades, called Shanghai and Capella, on Apr. 12, which will enable withdrawals of staked ETH for the first time.
Some of that ETH is staked through Coinbase. The exchange launched cbETH last August, taking ETH deposits in exchange for cbETH, a liquid staking token. After the upgrade, users will be able to redeem cbETH for ETH, but the mechanism by which they do so will be dictated by Ethereum protocol, according to a post by Coinbase.
Withdrawals will be queued, meaning that not all the ETH can be unstaked at once. Lei underscored that if people are rushing to redeem their cbETH, there may be even less liquidity for the token.
That potential lack of liquidity would increase the price impact of cbETH sales, increasing the likelihood of cascading liquidations and bad debt for Aave.
It all comes down to cbETH holding its peg to Ether, however. “If the price of cbETH relative to ETH remains stable, these risks are not a meaningful concern,” Lei said.
AAVE is up around 15% in the past month.