Lessons in Stability and Risk Management in DeFi: The ezETH Depegging Incident
The DeFi space faced a major shock in April 2024 when ezETH, Renzo’s native token, experienced a significant divergence from the price of its underlying asset, Ether (ETH). This event, known as depegging, occurs when stablecoins fail to maintain their fixed value and lose value compared to the underlying asset.
On decentralized exchanges like Uniswap, ezETH plummeted to $688 at its lowest point, causing panic among investors. Although the token has since recovered, it still remains at a discount of around 2% compared to ETH.
The depegging of ezETH is not an isolated incident in the DeFi space. Similar incidents have occurred with other liquid-staked derivatives, most notably with Lido’s stETH. Historical data shows that stETH has experienced depegs of up to 25% during periods of market volatility.
In this article, we will delve into the causes and effects of the ezETH depegging and explore potential solutions. We will examine how leveraged staking protocols like Gearbox and Marginly address depegging and assess the resilience of their technology in handling potential consequences.
Unraveling the Chaos: Understanding the Causes of Depegging
The primary catalyst for the ezETH depegging was an announcement from Renzo that included a highly confusing and inaccurate pie chart depicting token allocations. This misrepresentation created panic among holders, who became concerned about the security of their investments. The absence of a designated allocation for airdrops further worsened the situation.
The timing of Binance’s Launchpool for REZ, a Renzo-related token, also played a significant role in the depegging. Participants in the Launchpool were able to stake FDUSD and BNB to earn REZ, and the release date for these tokens was set just two days before the ezETH airdrop. The disparity in rewards between joining the Launchpool and holding ezETH led to a mass exodus.
Unlike its competitor, Ether.fi, Renzo lacked a withdrawal mechanism, which forced many users to liquidate their holdings on DEXs, further driving down the price. The delay in implementing a withdrawal feature greatly contributed to the panic and subsequent sell-off.
Could This Crisis Have Been Averted?
Had the Renzo team adopted an open communication model, much of the panic could have been alleviated. They could have avoided confusion by providing an accurate and well-explained token allocation plan, instead of relying on an inaccurate pie chart.
Introducing a withdrawal mechanism before launching the farming feature could have reduced the likelihood of panic selling by allowing ezETH holders to redeem their tokens directly for ETH. This strategy, successfully implemented by Ether.fi, maintained stability through early adoption of withdrawal features.
Furthermore, ensuring sufficient liquidity on third-party platforms can help stabilize token prices. Increased liquidity can absorb some of the selling pressure and prevent sharp declines.
Users should also exercise caution regarding potential bank run-like scenarios, particularly when farming operations cease. Sudden stops in farming, as observed in Pendle pools and maturity dates, can lead to rapid liquidity withdrawals and price declines.
Notable Perspectives on the Situation
Gearbox offers an optimistic oracle that leverages Chainlink and Redstone oracles for reliable price feeds, enhancing flexibility and security. It enables borrowing, swapping, trading, and opening positions in a single transaction with multicall features. However, active management from regulators and borrowers is necessary to address the associated risks, which can lead to complexity.
Marginly, a smart contract-based platform for leveraged staking and trading, prioritizes decentralization, risk segregation, and efficient liquidity management. By relying on on-chain oracles and eliminating off-chain dependencies, Marginly enhances security and predictability. Its “Liquidity Infinity Loop” mechanism allows effective asset reuse, while the deleveraging mechanism mitigates liquidation risks.
To set risk parameters, Marginly utilizes historical returns, simulations, and statistical calculations. It also assesses asset volatility through volatility cones and historical data to determine interest rates, adjusting them with a scaling coefficient for stability.
Addressing Depegging in a Systematic Manner
Marginly tackles thin liquidity by managing external and internal risks. Externally, liquidity limits are set to minimize slippage during trades on decentralized exchanges like Uniswap. Internally, a deleveraging mechanism balances positions within the pool, preventing deadlocks or excessive price impacts.
The platform integrates TWAP (Time-Weighted Average Price) oracles from Uniswap v3, providing reliable price data and enhancing resilience against manipulation. Marginly’s modular architecture supports various oracles, adapters, and exchanges, allowing the platform to adapt to market conditions and seamlessly integrate new data sources. This flexibility ensures accurate pricing and liquidity data, crucial for maintaining stability and efficiency in margin trading.
In Conclusion: Lessons Learned and Future Implications
The ezETH depegging incident has shed light on several essential lessons for the DeFi community. Clear and transparent communication is vital; the confusion caused by Renzo’s inaccurate token allocation announcement emphasizes the need for precise information to maintain investor confidence.
Furthermore, ensuring sufficient liquidity on third-party platforms is crucial to absorb selling pressure and stabilize token prices.
The ezETH experience serves as a valuable learning opportunity, reinforcing the significance of robust risk management, effective communication, and adaptive strategies in navigating the volatile landscape of DeFi. As the industry evolves, these lessons will be pivotal in shaping more resilient and secure financial ecosystems.
