Peak fear has passed. Just a few weeks ago it felt like every new day brought fresh and shocking revelations of some insolvency, or some overlooked systemic risk that was in the process of imploding, or some other thing that was going to send it all to zero. We've been through a lot.
But my guess is that the tide has turned. Yes, further CeFi lender insolvencies could crop up. And yes, there could be additional forced liquidations from these guys. But I think that's more or less been priced in. I wouldn't expect more of these kinds of headlines to produce further waves of panic. My guess is that what we've got ahead of us here from a market's perspective is just a protracted period of time that's going to feel like stagnation.
To be fair, I could be wrong. There could be further systemic risk that the market isn't pricing in. In particular, Aave's stETH exposure makes its platform risky in a way that the market hasn't really acknowledged in my opinion. We're probably through the worst of the market turbulence this cycle so we're probably in the clear at this point, but it bears mentioning how much latent risk that protocol has built up.
Aave has $1.5 billion worth of stETH held as collateral against loans on their platform. That number is absolutely massive compared to the total market liquidity for stETH. There is only ~$180 million worth of ETH in the stETH curve pool. A forced liquidation of 20% of Aave's stETH collateral would drop the stETH/ETH exchange rate to less than 0.60. Now, of course you wouldn't expect the price to stay there. But in a time of stress it wouldn't matter that the price would eventually snap back. Given that the majority of the stETH collateral on Aave is backing highly levered ETH/stETH positions, an stETH liquidation cascade is totally possible. And it could effectively blow out the entire protocol. Let's hope that doesn't happen!
So what does this all mean for DeFi rates? For the foreseeable future, more of the same I'm afraid. I wouldn't expect rates to move much from here. DeFi might just be about to get *gasp* boring for a while.
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