Degens borrowing ETH to get fork tokens create headaches for DeFi platforms

Published at: Sept. 7, 2022

The growing number of speculators taking out Ether (ETH) loans to maximize their potential to earn forked Ether Proof-of-Work tokens (ETHPoW) has been causing headaches for decentralized finance protocols.

The issue has been gaining traction over the past month or so, given that a significant number of Ether miners are expected to continue working on a forked PoW chain, or possibly even multiple chains post the long awaited Merge.

In the event of a fork, on-chain ETH hodlers such as those using non-custodial wallets or those holding on exchanges that are supporting ETHPoW will be airdropped the equivalent amounts of the new tokens to their ETH holdings.

This is because your ETH balance on the existing chain will be duplicated on the forked PoW chain.

On Sept. 6, the Aave governance community overwhelmingly voted in favor of halting ETH lending “in the interim period leading up to the Merge.”

This proposal was initially put forward on Aug. 24 as result of the demand for Aave ETH loans surging to levels that were starting to put pressure on the liquidity supply.

Aave has a complex structure for issuing interest rates, and utilizes algorithms to determine percentages taking into account the liquidity and demand for borrowing on the platform.

“Once the ETH borrow rate reaches 5%, which happens shortly after 70% utilization rate (we are at 63% right now), stETH/ETH positions start becoming unprofitable,” the proposal stated as of Aug. 24.

It was added that if these positions do start to become unprofitable, users would likely race to “unwind their positions up until the ETH borrow rate reverts to a stable level where the APY [Annual Percentage Yield] becomes tolerable.” As such, this would put even more pressure on liquidity supply of ETH on Aave.

The vote yesterday polled 77.87% in favor (528,290 people) and 22.13% against (150,170 people), and the proposal was executed on the same day.

Earlier this week another DeFi lender Compound Finance also had a forked Ethereum risk mitigation-related proposal that was voted through, and notably had zero votes in opposition to the 347,559 in favor.

Compound’s idea, which went live as of Sept. 5, was to set the borrow cap at 100,000 ETH until the dust from the Merge has settled.

Additionally the protocol updated its interest model to a “jump rate model with much higher rates after exceeding 80% borrow utilization” which bumps to a maximum rate of 1000% APR if 100% utilization is reached.

The hope is that this will deter users from overwhelming Compound with borrowing and withdrawals from the platform.

Proposal 122 prepares for the Merge and a potential POW fork by protecting cETH user liquidity.It imposes a borrowing cap of 100,000 ETH, and introduces a new interest model with very high upper bounds.Voting begins in 2 days.https://t.co/7LvUk1lOk7https://t.co/krTBxFUQEe

— Compound Labs (@compoundfinance) September 2, 2022

ETH outflows on exchanges

Users are certainly positioning themselves to get free tokens,despite numerous stablecoins and projects distancing themselves from a PoW chain.

Delphi Digital’s latest report notes that despite declining price of ETH of late, exchanges saw outflows totaling 476,000 on Aug. 29.

This marks the third largest amount of ETH withdrawals since March, and the firm attributed this to Merge and investors repositioning to collect ETHPoW tokens:

“To collect the most amount of ETHPoW tokens, users are likely withdrawing ETH balances from centralized exchanges to non-custodial wallets, leading to an increase in the net outflow of ETH from exchanges.”

While it is unclear if the forked chains will attract strong enough interest to develop a lasting ecosystem and community, in the short term crypto degens at least seem keen to gobble up free forked tokens.