Instadapp Lite Vaults v2 - Risk Assessment by BA Labs
Assessment Summary
- BA Labs supports onboarding the Instadapp Lite v2 ETH vault as an ARK to the Higher risk ETH Fleet on Mainnet
- Reference parameters for Instadapp Lite v2 ETH vault will be provided in a separate post below
Overview
Lite vaults (v1) were launched in March 2022 by the Instadapp team who have a proven track record considering their presence in Ethereum DeFi since 2018 by building Instadapp Dashboard (now Instadapp Pro) for managing MakerDAO CDPs initially, and later on aggregate numerous DeFi lending and DEX protocols.
The idea behind the Lite vaults v1 was to offer a 1-click yield solution while depositors receive the proof-of-deposit token, aka iTokens (e.g. iETH). The approach of Lite vaults is pool-based LP-ing, meaning the capital deposited is used to create a single (leveraged) position (e.g. stETH/ETH) in the underlying lending protocol (e.g. Aave v2), while the management of the capital was essentially done by the Instadapp team.
stETH depeg in 2022
While Lite v1 vaults reached ~$200M across four vaults (4 different deposit tokens), the ETH Lite v1 vault was put through the test when stETH lost its peg in the aftermath of the Luna meltdown, around 2 months after the Lite v1 launch. Being one of the biggest stETH leveraged positions in the ecosystem, Instadapp team was advised by LidoDAO to reduce the size of Lite positions due to the increased risk from stETH depegging and market illiquidity. Since this would essentially increase the chances of cascading effects and liquidating many other leveraged positions widening the peg furthermore, the Instadapp team and investors took actions of topping up collateral to the Lite vaults (~$35m) to protect the vaults from a stETH price depeg.
To further protect the Lite vaults, the Lite vaults were unwinded by 25,000 ETH, which resulted in ~500 ETH loss due to the price variance between stETH and ETH at that time.
Instadapp team made sure that Lite depositors’ losses were fully covered by paying back from their Treasury.
Lite Vaults v2
In Feb 2023 the v2 of Lite Vaults was released, introducing a single ETH vault. It leverages the new ERc-4626 standard, opening the door for the composability of iETH tokens across DeFi protocols, although, as of now there were no known (to BA Labs) lending venues offering iETH as collateral.
Lite v2 also brought the option to distribute stETH/ETH positions across multiple underlying protocols (v1 utilized Aave v2 only) as an act of risk diversification and targeting highest net APY. At the time of writing, supported protocols are: Aave v3, SparkLend, Compound v3, Morpho Blue, and Fluid.
Risk considerations of pool-based leveraged vaults in v2
Counterparty risk
- Mgmt fee - The ETH vault charges 20% on profits, and a 0.05% exit fee. All fees earned by Instadapp Lite go to the InstadappDAO.
Lite v2 vaults are upgradable by the DAO governance which can adjust fees, add/remove underlying strategies/protocols, assign (permissioned) roles (deposit, withdraw, leverage, and refinance (reallocate between protocols)) to “Rebalancer” accounts, etc.
It’s important to note that team multi-sig can be used to reduce ratios for a particular protocol and can ‘pause’ the vault by either pausing withdrawals or rebalancing. These functions do not change the ownership of the assets and do not prevent users from trading or transferring the underlying iToken.
Withdrawal risk
Lite vaults essentially have limited withdrawals, although v2 introduced 50% of capital to be withdrawn instantly without incurring any loss, thanks to the multiple underlying lending (yield) protocols.
Depeg/Unwinding risk
Here we note that with the launch of Lite v2, the stETH depeg risk has been significantly reduced with the combination of Shanghai upgrade in April 2023 (enabling staked ETH withdrawals), and the Instadapp’s stETH redemption protocol introduction.
The stETH Redemption Protocol significantly reduces the costs associated with deleveraging stETH/ETH (Lite v2) positions. By taking short-term loans against ETH in Fluid, protocols/users can unwind their leveraged positions at a fraction of the cost compared to traditional selling on the market.
The stETH Redemption Protocol serves as a specialized mechanism for efficiently deleveraging stETH/ETH positions by utilizing Lido’s receipt NFT as collateral during the redemption process. Once the ETH is withdrawn from Lido, the position is deleveraged using the newly released ETH to pay back the ETH debt (deleveraging the entire position) and sending the remaining ETH back to the user. This eliminates the need to maintain a 25% reserve for Lido redemptions, allowing for those 25% of the vault’s assets to be actively engaged in its strategic operations, potentially enhancing returns for users by 30-50%.
Rebalancing (gas) costs - also became negligible according to the e.g. 6m or 1y gas price data (thanks to the Dencun upgrade). This reduction in gas costs makes rebalancing operations much more affordable than in the past. The “Rebalancer” role, which is an on-chain account responsible for executing rebalancing transactions, is crucial for the vault’s health. While the exact incentives for “Rebalancers” are not explicitly documented, we still need to consider whether the operations are sustainable. Gathering historical data, we found that the total gas cost in the last two months was around 0.78 ETH, paid by the rebalancer 0x10F37Ceb965B477bA09d23FF725E0a0f1cdb83a5. The total value generated by the vault during the same two months can be estimated at around 596 ETH, taking into account the current APY of 5.56%, which means gas costs were approximately 0.13% of the yield generated in the same period. Thus, the overall APY of the vault would need to be slightly adjusted down by approximately 0.0073 percentage points, e.g. from 5.56% to 5.5527%, if the gas costs were passed on to users, which shows that it is completely sustainable at the current TVL.
