Chaos Labs: Aave's $4.7 billion exposure to Ethena could trigger a "liquidity crunch"

PANews reported on August 5th that, according to DL News, Chaos Labs, Aave's risk advisory firm, posted on the Aave governance forum that the increasing amount of USDe deposited into the Aave protocol could threaten Aave's resilience and trigger a liquidity crunch. USDe holders are depositing large amounts of the token into Aave, while its issuer, Ethena, is lending out the stablecoins backing the asset, posing a significant risk. Ethena must avoid depositing excessive stablecoin reserves into Aave, self-limiting this risk exposure to help maintain the integrity of the redemption mechanism and market stability.

Ethena has deposited $580 million of USDe-backing assets with Aave, a strategy known as rehypothecation. Furthermore, Aave currently holds $4.7 billion in USDe-backed assets, including PT and sUSDe, representing over 55% of the total USDe supply. Chaos Labs stated, "The dual role of backing assets, serving as both redemption capital and liquidity for Aave, creates a vulnerability that could exacerbate stress on both protocols during deleveraging events." Because USDe's backing mechanism has a growth and contraction cycle, redemptions by USDe holders could pose problems during bearish market conditions if backing assets are lent out. Its recycle strategy exacerbates this risk, potentially tightening Aave's liquidity and raising lending rates, triggering a chain reaction. However, there's no immediate cause for concern, as the unwinding of recycle positions during the contraction period could offset the surge in utilization. However, this situation could change as USDe grows or rehypothecation increases. Chaos Labs is developing new risk prediction tools to adjust interest rates and ensure orderly redemptions during periods of market stress.