If you were borrowing ETH before the merger, this article might be worth a look. With a few days to go until the merger, we can see more clearly what the DAO is preparing for and how it will affect lenders or borrowers.
Currently, the three largest lending protocols on Ethereum are all moving in different directions.
If you are an ETH lender or borrower right now, keep an eye out. In the coming days, there may be significant differences in interest rates and borrowing utilization between these agreements, which may affect your profit or loss. Let's see how traders affect the lending market. The merge transaction on the lending protocol is pretty simple: people borrow ETH and get "free" PoW ETH from the inevitable cash-grabbing PoW fork after the merge. Of course, nothing in this world is free. Borrowing ETH costs your ETH. How much interest you pay depends on how early you start borrowing ETH and the variable rate you pay every moment. Still, someone is definitely excited about the deal. It has pushed up borrowing rates on ETH, especially on Aave. This prompted Aave to take action . In order to prevent withdrawal issues, liquidation issues, and prevent further declines in the profitability of leveraged staking, the Aave community has voted to suspend further borrowing in an attempt to prevent further increases in borrowing usage (more on that later).
Meanwhile, Compound Finance is working on a different type of proposal to increase the maximum borrowing rate on ETH to 1000% APY to limit the maximum usage potential.
How effective are these proposals? How will they affect traders? First, note that at the time of writing, PoW ETH is valued at about 3% of the value of ETH on the futures market. We can use this to determine the maximum amount of interest a borrower should be prepared to pay in order to obtain PoW ETH. For every $100 of ETH borrowed, they should pay no more than $3 worth of ETH in total interest until combined. So, if we are 1 day away from the merger, and there is ETH to borrow, and the annual interest rate is less than 1095%, then you might as well borrow. You should be prepared to pay 1/365 * 1095% APY of the loan in one day, as this equates to 3% APR (earnings for PoW ETH). In order to make a profit, you should obviously borrow at a lower interest rate. If possible, you should also save your borrowing until the last minute to lower your interest rate. But what about front-running? If you stay until the end, the borrowing utilization rate will not reach 100%, and you are missing out? Yes, but that doesn't mean borrowing early is a good strategy.
In fact, if you've already borrowed on Euler Labs/Compound Finance/Aave, I might have bad news for you. The problem is that when trying to forecast your borrowing costs, you have to price in the latecomers who are most likely to increase borrow utilization to 100%, even if only for a short time. why? Because if you choose a lending protocol that supports a maximum borrow APY of 1000% (eg Compound Governance Proposal), then anyone who didn't borrow at less than that rate the day before the merger just missed out on making money. So even if you're only paying 5% APY right now to protect your position and feel fairly comfortable, you almost certainly have to account for 1/365 * 1000% APY ~ 2.7% on the last trading day before the consolidation annualized interest rate. Because of this, I bet many people who are borrowing ETH now will pay more in interest when the merger arrives than they hope to earn in PoW ETH.
In contrast, if your lending agreement supports a maximum borrow APY of 100% (such as Euler is now), then you can "safely" borrow at maximum APY for nearly 11 days before the merger, and will not pay more than you earn To PoW ETH more ETH interest. This is because 11/365 * 100% APY ~ 3% annualized cost of borrowing. So even if Euler hits 100% APY tomorrow, you can still break even in a week or so when PoW ETH hits your wallet. The possibility of locking in a "profitable" deal early like this could push up Euler's borrowing utilization in the coming days, well before the merger takes place. Isn't it bad? Maybe, but lending protocols don't exist in a vacuum.
Since interest rates on Euler are higher than other protocols, new lenders may be tempted to migrate for a higher APY. In fact, many lenders may be happy to receive a high ETH APY and sacrifice a day or two for withdrawals rather than holding ETH directly to claim PoW ETH. After all, the latter is a token of questionable value that may be difficult to dispose of after a merger. Why not lock in some profits by lending ETH directly? As for the question of whether a moratorium on borrowing would protect lenders, I personally think that is unlikely to be achieved. That's because a borrowing moratorium doesn't guarantee low borrow utilization; it just creates a one-sided market.
In my opinion, one-sided markets almost never work out well and should generally be avoided, as I advocated before the stETH "decoupling" collapse. Just like the borrower borrowed before the merger, the lender has a good reason to withdraw ETH before the merger. The lender's withdrawal of ETH supply and the borrower's borrowing of ETH have the same impact on the borrowing utilization rate.
If the borrow utilization rate is not 100% by the last day, why not withdraw your ETH, withdraw your PoW ETH, and then deposit ETH again shortly after? This way, you get all the benefits of speculative borrowing ahead of the event. As a lender, you may want to withdraw money for many other reasons. You might be worried about being liquidated on a leveraged collateral position, or worrying about the risk to the price of ETH after the merger, or seeing a fat interest rate on another lending agreement. In any case, borrowing rates appear to be skyrocketing ahead of the merger, and lending protocols could reach 100% borrowing utilization regardless of the protocol's strategy. How long may depend on the agreement's top rate and whether borrowing is suspended.
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