DeFi Risks Following Market Crash

In the aftermath of the market crash on October 10, which resulted in significant losses for Bitcoin, nearly $1 billion in decentralized finance (DeFi) positions tied to Ethena-backed USDe (sUSDe) face potential risks, as highlighted in a recent report by Sentora Research.

Following the crash, interest rates within the DeFi market have dropped dramatically, leading to reduced yields for leveraged strategies like sUSDe loop trading. To clarify, sUSDe is Ethena’s staking version of USDe, a synthetic dollar stablecoin designed to generate yield through the staking of the USDe token.

The Loop

A common trading strategy involves using sUSDe as collateral on DeFi platforms such as Aave or Pendle to borrow stablecoins like Tether. Essentially, traders use borrowed USDT to buy more sUSDe, then redeposit that as collateral to secure additional USDT for further purchases of sUSDe.

This repeating cycle is supposed to enhance yield through positive carry, which relies on the difference between staking rewards from sUSDe and borrowing costs.

Negative Carry

However, since the crash, this dynamic has flipped. The yield differential has become negative, dampening the appeal of loop trading. Sentora Research remarked, “After the flash crash on October 10th, funding rates in the DeFi market dropped considerably, leading to diminished yields on basis trading strategies. Currently, the borrowing rates for USDT and USDC in Aave v3 core are approximately 2.0% and 1.5%, respectively.” These rates are now higher than sUSDe’s yield, making carry negative for those borrowing stablecoins to utilize sUSDe.

The firm noted that as the yield spread stays below zero, loop positions that borrow stablecoins to invest in sUSDe may start to suffer losses. If this trend continues, it could result in the unwinding of about $1 billion in positions already vulnerable to negative carry in the Aave v3 core.

This situation could lead to forced sales of collateral and deleveraging, which would weaken liquidity on leveraged platforms and might trigger a cascade of market instability.

What’s Next?

Centra urges traders to be cautious of the gap between Aave’s borrowing annual percentage yield (APY) and the yield from sUSDe, particularly if this difference remains negative.

Increases in borrowing costs could further intensify pressures, especially given that there’s been a spike in loop positions nearing liquidation—many close to 5% from forced closure.

Moving forward, traders are advised to monitor the utilization rates of USDT and USDC loan pools, as any substantial rise could escalate borrowing costs and add to the strain amid the negative yield spread between Aave’s and sUSDe’s rates.