[TEMP CHECK] Security Module Update Part I – Migration of AAVE/wETH Balancer v1 Pool to Balancer v2 – Governance

Title: [TEMP CHECK] Security Module Update Part I – Migration of AAVE/wETH Balancer v1 pool to Balancer v2
Author: @Llamaxyz – @dydymoon & @TokenLogic
created: 04/13/2023

The post suggests creating a new AAVE liquidity pool on Balancer v2 and adding the BPT to Aave’s Safety Module (SM).

The SM currently accepts two deposit tokens, AAVE and ABPT. The ABPT is an 80/20 AAVE/wETH Balancer v1 liquidity pool receiving token. Balancer v1 is now deprecated and the main AAVE liquidity pool needs to be migrated. This publication presents several pool options to consider when migrating the AAVE Main Decentralized Exchange (DEX) liquidity pool and whether to include the Receive Token (ABPT) in the Aave SM.

Given that Balancer DAO has adopted a veTokenomics model, if given a benchmark and incentivized, the new AAVE liquidity pool would represent an alternative source of revenue that carries no risk of default. This is an important consideration when estimating the cost of leasing backstop liquidity to users within the SM.

This post aims to identify which liquidity pools should be created on Balancer v2 and whether these ABPTs should be included in Aave’s SM.

By depositing AAVE and ABPT into the SM, depositors receive stkAAVE and stkBPT, respectively, as well as the return nominated in AAVE. Daily 550 AAVE will be distributed to users using AAVE and another 550 AAVE will be distributed daily to depositors using ABPT. In exchange for AAVE returns, depositors risk up to 30% of their capital by providing hedging for the Aave liquidity pools.

Currently, the ABPT accepted in the SM is representative of a liquidity position on Balancer v1, 80/20 AAVE/wETH. The first part of this proposal focuses on whether to migrate AAVE liquidity to Balancer v2 and if so, what pool composition should be considered. For the remainder of this post, it is assumed that Aave would like to continue to have the primary AAVE liquidity pool on the balancer protocol and other DEX providers will not be considered.

This release excludes BPTs with Balancer Linear Boosted Pools that deposit funds into Aave v3 deployments from inclusion in the Aave SM, as using deposits into Aave as a backstop to Aave introduces systemic risk. This pool type is still worth considering as it is the main AAVE liquidity pool or for the StakedATokens but will not be included in the SM.

Non-Aave boosted pool pairs were also excluded from this proposal at initial review due to increased risk surface beyond the Balancer and Aave protocols, but could still be considered if the community decides so, so long the underlying strategy is completely unrelated to Aave. There are alternative ways to improve capital efficiency for liquidity providers with better risk/reward trade-offs. One example is established and battle-tested Liquid Staking Tokens (LST).

Given the SM’s overexposure to the AAVE token, the options below will focus on reducing AAVE weights and explaining the pros and cons of each option. In this publication, the following four Balancer v2 liquidity pool options are put up for discussion:

1. 80/20 AAVE/wETH
Like-for-like pool migrating v1 to v2
2. 80/20 AAVE/wstETH
Like-for-like migration with improved capital efficiency
3. 50/50 AAVE/wETH
Reduces AAVE concentration in SM and increases wETH
4. 50/50 AAVE/wstETH
Reduces AAVE concentration and increases capital efficiency by incorporating the dominant ETH-LST

In the future, an AAVE/GHO pool could be created and introduced for testing in the SM.

Option 1 – 80/20 AAVE/wETH

This option only requires users to rebuild the same pool to version 2 and migrate it.

Option 2 – 80/20 AAVE/wstETH

Option 2 is the same as option 1 but replaces the unproductive wETH with wstETH. There is an additional risk to consider with the inclusion of an LST compared to wETH and the additional return it offers liquidity providers.

Option 3 – 50/50 AAVE/wETH

This option changes the pool weight from 80/20 of the existing pool to 50/50 when the new pool is provisioned. Adding this pool to the SM will increase the share of wETH within stkABPT deposits. However, it is expected that due to the even composition of the pool, the pool would suffer a greater temporary loss, which could lead to higher reward expectations.

Users migrating directly will need to add wETH to their liquidity taken from the Balancer v1 pool when depositing into the new 50/50 pool to avoid triggering a swap on deposit.

Option 4 – 50/50 AAVE/wstETH

The Option 4 pool could be turned into a balancer core pool by replacing wETH with wstETH as the core pools require at least 50% of an interest bearing token (IBT).

For comparison, 50% of the income generated by the IBT is confiscated, with 65% used for bribes via Hidden Hand as voting inducements and the remaining 35% retained by the balancer DAO. The balancing team is responsible for claiming and distributing part of the proceeds to win veBAL votes.

Considering that the Shanghai upgrade date is confirmed, the risks of LST decoupling and liquidity are reduced over time, which would make it a good asset in the SM.

Llama suggests keeping the 80/20 balancer pool v1 composition and replacing wETH with wstETH when deploying the new balancer v2 pool. This publication favors option 2 due to the additional capital efficiency of including an LST compared to wETH and notes that the majority of ETH-correlated liquidity on Balancer v2 is nominated in wstETH. There are also potential benefits of BAL rewards that are significant given current Aave roadmap considerations.

If the Aave community is interested in tracking this pool, Llama will continue to seek assistance from Balancer, Aura and other communities to determine if Aave would be eligible to participate in the 80/20 incentive program. The wstETH component plus swap fees would help meet the pool’s revenue contribution requirements. While the security module timeout is only 3 weeks, it contributes to the 16 week timeout requirement mentioned in the proposal linked here.

Given that the AAVE/wETH pool currently has $117M in liquidity, migrating 100% of the pool would almost meet the top TVL requirement ($140M at $7/BAL ). If 20% of the pool is held in wstETH and a return of 4.5% is achieved, this equates to a wstETH-nominated return of $1.05 million. If Balancer received 50% of this wstETH yield as earnings, Aave could receive the maximum 250,000 BAL provided other conditions are met during the term of the program. See this forum post and an amendment to the original proposal for full details.

The migration requires users to turn on the cooldown, un-stake the BPT v1, withdraw the liquidity, deposit into the new pool, and stake again.

This can be implemented independently of the following parts. In this case, a “classic” measuring device is required. Alternatively, gauge design is discussed in Part III.

• Migrate SM infrastructure to Balancer V2 (BGD)
• Create the new pool depending on the voting results (balancer / llama).
• Add support of new pool in SM (BGD).

Continue the discussion in the comments. After a reasonable period of time, the following options should be put to the vote.

1. YAE – 80/20 AAVE/wETH
2. YAE – 80/20 AAVE/wstETH
3. YAE – 50/50 AAVE/wETH
4. YAE – 50/50AAVE/wstETH
5. NAE – Revision Proposal
6. WAIVE

@bgdlabs is currently pushing an upgrade of the SM architecture to support the launch of GHO. You can find the details here.

Links to the Llama publications are below:

1. [TEMP CHECK] Security Module Update Part I – Migration of AAVE/wETH Balancer v1 pool to Balancer v2
2. [TEMP CHECK] Security Module Upgrade Part II – Asset Diversity, SM Categories and Slashing Updates
3. [TEMP CHECK] Security Module Upgrade Part III – Enable gauges on the BPT in the Security Module (smBPT).
4. [TEMP CHECK] Security Module Upgrade Part IV – Incentive Management Upgrade
5. [TEMP CHECK] Security Module Upgrade Part V – veToken Holding Management Framework
6. [TEMP CHECK] Security Module Upgrade Part VI – Future Considerations

The llama is not compensated by any of the named communities outside of Aave.

Llama is an unpaid delegate within the balancer ecosystem.

Members who contributed to this proposal are not angel investors or advisors to any of the communities mentioned, but some hold small stakes in the tokens of those communities.

Copyright and related rights are waived via CC0.

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