Aave recently incorporated tETH into its Core Instance, raising significant concerns about systemic risk in the market. As a “leveraged” staking derivative, tETH will create a higher risk structure once it enters Aave’s collateral lending. With the increasing possibility of chain defaults, institutional capital may continue to keep Aave and other DeFi protocols at arm’s length.
What is tETH? The Risks of “Leverage on Leverage”
tETH, short for “Treehouse ETH,” is issued by the yield protocol Treehouse Protocol, which currently boasts a total locked value (TVL) of $500 million. It uses wstETH (Lido’s wrapped staked ETH) as its underlying asset and leverages staking yields through a circular lending strategy. In other words, tETH itself is a “already-leveraged ETH staking token.”
Recently, the Aave community proposed and approved the acceptance of tETH as collateral, allowing users to re-collateralize tETH to borrow stablecoins, effectively creating “leverage on leverage.” Although this mechanism theoretically amplifies returns, the actual risks are quite alarming.
Delphi Digital analyst Simon stated, “A few weeks ago, we witnessed cases of massive losses due to slight changes in interest rates.” However, in the current market, where interest rate spreads have reached historical lows, redemption queues are at an all-time high, and liquidity is tight, any further interest rate fluctuations could have even more severe consequences.
(ETH unlocks queue reaches new high! Over $3.8 billion awaiting withdrawal, understand the reasons all at once)
He is more concerned that tETH has simultaneously gone live on Aave’s Core and Prime markets, effectively nullifying the original isolation design. If tETH experiences a default, the chain risks could rapidly spread across different markets, increasing system vulnerability.
Joining Forces with Ethena, Integrating Treehouse: Is Aave’s Risk Curve Skyrocketing?
Aave has long been a leader in the on-chain lending space, with a TVL of $36.4 billion, known for its diverse asset support and deep liquidity. However, Simon points out that Aave’s increasing exposure to synthetic asset stablecoins or derivatives like Ethena and Treehouse has sharply escalated the overall risk curve.
(Altcoin fatigue spurs demand for yield stablecoins: Ethena USDe scales up 75% monthly, surpassing $9 billion)
For retail investors seeking high returns, such designs are indeed attractive. However, for conservative players or large financial institutions, Aave’s actions may not be so favored, as they fail to meet the fundamental requirements for stability and manageable risk:
“While I like Aave, I do not wish to spread pessimism here. However, I believe institutional capital will likely not choose Aave when entering DeFi lending pipelines.”
S&P Rating Sky Issues Warning: Leverage Risks Push Aave Further from Traditional Finance
As indicated by S&P Global’s recent high-standard attitude towards the credit rating report of the lending protocol Sky Protocol (formerly Maker), if DeFi protocols want to genuinely connect with traditional finance, compliance and security must take precedence. Even slight disconnections in stablecoin fluctuations could be defined as default events.
The agency assigned Sky a rating of “B-,” citing risks such as high concentration of depositors, highly centralized governance, and insufficient protocol surplus reserves.
(S&P gives Sky Protocol a “B-” credit rating for the first time; is DeFi protocol destined to be excluded from traditional finance?)
Aave and Treehouse’s push for high-leverage products may bring short-term returns and attract crowds, but they are difficult for conservative capital to accept.
Market Diversion: Institutions and Retail Investors Want Different Things
Aave’s inclusion of tETH as collateral is a bold experiment combining high risk and high returns. As the call for DeFi to connect with traditional finance grows louder, compliance, security, and risk management are no longer optional but mandatory.
While the basic threshold for entering TradFi is indeed high, products that cross that threshold are expected to become the standard answers for accommodating traditional capital inflow in the future.
Risk Warning
Investing in cryptocurrencies carries a high level of risk, and their prices can be extremely volatile. You may lose all your principal. Please assess the risks carefully.