MakerDAO’s suspension came as crypto lender Celsius borrowed 100 million DAI against a collateral of stETH out of every 200 million DAI borrowed from Aave’s Ethereum V2.
Aave’s platform allows users to lend, borrow, and accrue interest on digital assets. One needs to post collateral for a loan to borrow digital assets from Aave. Collateralization in DeFi works much the same way as traditional finance, albeit a bit more technical.
When taking out a mortgage to purchase a house, for example, borrowers typically post the homes they intend to purchase as collateral. If they can’t pay back the loan, their agreement with the bank allows the bank to repossess the house.
DeFi is no different. Suppose users do not pay back a loan, or their loan value exceeds their collateral. In that case, the collateral will remain in the protocol and be used to repay their loans to the liquidity pool.
Third parties will be able to bid on the collateral in much the same way a repossessed house is placed on auction and sold to the highest bidder. Ultimately, the smart contract governing the transaction will “sell” or “liquidate” collateral to pay loans.
Celsius exposed lenders of DAI to instability of stETH
By Celsius borrowing 100 million DAI by depositing stETH, a derivative of ETH, it was exposing the lenders of DAI to the instability of the derivative token.
One stETH will be redeemable for one ETH after the Ethereum 2.0 upgrade is complete, and withdrawals are enabled. Due to the recent market crash, which saw ETH dip sharply, many holders have been selling their stETH, driving its price lower than ETH. Consequently, pausing DAI deposits effectively prevents borrowers from taking out loans against stETH.
stETH in the headlines this week
Last week, Celsius recently faced liquidations of stETH collateral amidst a suspension of withdrawals. In what rumors called a “bid” to shore up the liquidity of ETH, crypto hedge fund Three Arrows Capital withdrew 80,000 stETH from Aave last week and then swapped 39,800 ETH for 36,700 ETH.
MakerDAO will convene in two weeks to discuss a possible reactivation of DAI deposits.
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