Ahead of the anticipated Ethereum merge slated between September 13 and 15, players like Aave are stocking up ETH. Some are even borrowing to increase their Ether balance. The DeFi platforms and others worry that user Ether borrowing may increase and leave the protocol prone to liquidity issues. They also worry that the increased borrowing may inject volatility into Lido’s stake market.
To prevent the risks, the Aave community has proposed a temporary suspension of Ether lending before the Ethereum merge.
This is because there are many uncertainties surrounding the upcoming Merge. This proposal was highlighted by Block Analitica.
Why Aave Community Voted For The Lending Suspension
The team pointed out that a potential Ethereum proof-of-work may cause loan providers to start a bank run. This may propel utilization to a much higher level, hence the need to pause ETH lending for now. The utilization level is the percentage of loaned out the pool, and it would rise since users may likely borrow ETH before the Merge.
The voting to approve the suspension occurred between August 30 and September 2. The suspension received a high vote in its favor from the Aave community.
Some ETH miners are fighting for the chain to be split into a proof-of-stake and proof-of-work. This is so that the proof-of-work chain will have ETHPOW as the native token to enable free ETH distribution to holders. This may be the reason for increased ETH borrowing to increase Ether balance.
A Binance.US researcher, Lan Unsworth, reported that users borrow Ether from lending protocols, especially Aave. Bobby Ong expects that the elevated utilization rate will jump from 70% to 100% if the lending continues.
Significance Of High Utilization
Lan Solot, a partner at TagusCapital, a crypto hedge fund, made a striking remark. He said that the borrowing pause was a great move. However, liquidating ETH borrowers when the market is volatile will become difficult due to scarcity caused by high utilization.
An increase in utilization to 100% will result in lending out almost all ETH. This will leave no collateral for liquidators to process regular liquidations of ETH borrow-base positions.
Liquidation, according to Aave, is a process that occurs when a borrower’s health factor is below 1. It happens when collateral value is not able to cover the loan value. Liquidators will be forced to closure because of a decline in collateral value.
According to Block Analitica, high utilization obstructs liquidation transactions and increases the chances of the collapse of the protocol.
The crash in the utilization rate may lift ETH borrowing to rates where ETH-stETH becomes profitable for Aave. This may, on the other hand, lead to the mass unwinding of positions. It could also reduce the injection of volatility into the stETH market.
Featured image from Shutterstock , Chart from TradingView.com