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Ethereum’s lending markets behaviors and preventions in regards to the upcoming merge
The awaited ETH merge is expected to happen on Thursday September 15th, 2022 during early hours of the morning (EST). This will mark the transition of Ethereum from proof of work into proof of stake,sunsetting traditional computing mining validation for token staking validation.
Along with this awaited change there is also great speculation surrounding possible chain forks at the time of the merge. The most prominent one ETH PoW or ETHW proposed by Chandler Guo, will allow the forked version to continue using the old validation method. In this way miners will remain active in the process of validating transactions for the forked blockchain.
This has created a great amount of speculation, since all ETH on-chain holders will be receiving an ETHW airdrop in the forked chain. The majority of tokens are expected to be worthless on forked chains, with the exception of ETHW which will serve as its native blockchain token. This has produced great volatility on Ethereum lending protocols, since traders are speculating on a possible chain fork happening by borrowing ETH on lending protocols in order to try to claim ETHW.
Major protocols on the Ethereum blockchain have taken different approaches regarding their ETH lending markets and the upcoming merge. As depicted in the table above this has affected the protocols and their borrowing rates in different ways.
Aave, the biggest out of the three in total value of ETH supply, submitted on its governance forum proposal AIP-97 in which it proposed to pause ETH borrowing on the Aave V2 markets on dates prior to the Ethereum merge. This one aims to prevent high utilization on the ETH market, which could lead to: liquidations being harder or impossible, cascade liquidations led by a downward price spiral of stETH and ETH lenders to start withdrawing their positions.
Compound also passed a proposal to adjust parameters for the ETH market. Specifically, the proposal implemented an ETH borrow cap of 100,000 ETH and updated the interest rate model with higher rates for when 80% borrow utilization is reached, this one will go to a maximum of 1000% APR for when 100% borrower utilization is achieved. This way, the protocol aims to ensure continuous withdrawal liquidity for Compound ETH collateral.
Unlike Aave and Compound, Euler decided to do nothing with ETH markets in regards to the upcoming merge. Their reasoning behind the decision is to first maintain an efficient market, which in theory will only be in high utilization for a short span of time and should self adjust based on market forces. Secondly, the protocol also targets to capture lenders that might seek to migrate positions in search of higher interest rates.
On the graph below, the historic borrow APY for Aave, the biggest ETH market, is visible. It can be clearly appreciated how the market has been affected by the speculation of claiming possible forked tokens.
Via Aave Dashboards
As depicted, the variable APY stands at 48.33% at the time of writing. This marks among the highest utilization points that the market has experienced so far. Since Aave borrowing markets have been paused in prevention of the merge utilization rates can only be driven higher by collateral withdrawal. Large withdrawals could cause possible increases from the optimal point utilization rate. At the time of writing the utilization rate stands 13% higher than the 70% optimal utilization rate.
This dynamic can be further explored by monitoring the supply and borrow amount of ETH.
Via IntoTheBlock’s Compound Indicators
The indicator above portrays Compound’s daily amount of deposits withdrawn from the ETH market. As it can be seen on September 7th, 2022 $204.4 million were withdrawn from the market, presumably to be able to claim the upcoming ETHW tokens since by being deposited into the market will not make it possible. As mentioned above these withdrawals also affect the ETH market utilization rate since there is less money available to be borrowed.
In this same way, exploring the borrowers market also provides an opportunity to understand the behavior of traders prior to the upcoming merge. The graph below depicts the daily amount borrowed by Compound users on their ETH market.
Via IntoTheBlock’s Compound Indicators
As it is seen, there are several large daily borrowings across the last month, with the highest day adding a total of $41.88 millions in total. It is presumed that this high amount of borrows are the result of trading speculation to obtain future ETHW.
In conclusion, the ETH merge is likely to bring great volatility and speculation to the market. There are still many possible scenarios that could take place and high risk positions could be seen heavily affected. The merge stands as an unprecedented event, which increases the level of risk and volatility on the market, but that does not seem to stop speculators as evidenced by activity on lending protocols.
Analysis of Ethereum On-Chain Lending Markets Prior to The Merge was originally published in IntoTheBlock on Medium, where people are continuing the conversation by highlighting and responding to this story.
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