Aave has suspended ETH lending until the Merge is completed, while Compound Finance has opted to cap the number of loans and introduce a “jump” interest rate model.
The growing number of speculators borrowing Ether (ETH) to increase their ability to obtain forked Ether Proof of Work (ETHPoW) tokens is creating challenges for decentralized finance (DeFi) protocols
The problem has caught on in the past month as a significant number of Ether miners are expected to continue working on a forked PoW chain or possibly even multiple chains after the long-awaited Merge.
In the event of a fork, on-chain ETH hodlers such as those using noncustodial wallets or those holding on exchanges that 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 is duplicated on the forked PoW chain.
On Tuesday, the Aave governance community voted overwhelmingly in favor of halting ETH lending “in the interim period leading up to the Merge.”
This proposal was originally made on August 24 as demand for Aave ETH loans rose to levels that were starting to put pressure on the liquidity supply.
Aave has a complex structure for issuing interest rates and using 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 started to become unprofitable, users would likely rush 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 the liquidity supply of ETH on Aave.
Yesterday’s 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 approved a forked Ethereum mitigation proposal that was passed with zero votes versus 347,559 in favor.
Compound’s idea, which took effect on Monday, was to set the borrowing limit at 100,000 ETH until the dust from the Merge has settled.
In addition, the protocol has updated its interest model to a “jump rate model with much higher rates after exceeding 80% borrow utilization,” which increases to a maximum rate of 1000% APR if 100% utilization is reached.
The hope is that this will prevent users from overwhelming Compound with loans and withdrawals from the platform.
Users are certainly positioning themselves to get free tokens, despite many stablecoins and projects distancing themselves from a PoW chain.
The latest report from Delphi Digital notes that despite the declining price of ETH of late, exchanges saw outflows totaling 476,000 on Aug. 29.
This is the third largest number of ETH withdrawals since March, and the company attributed it to Merge and investors who have repositioned themselves to raise ETHPoW tokens.
While it’s unclear whether forked chains will generate enough interest to develop a lasting ecosystem and community, in the short term crypto degens at least seem keen to devour free forked tokens.
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