Thanks for starting this conversation in the forum about Exchange vs Market rate price feeds. Regarding the current liquidity for LSDs, the data below indicates that there have been no negative trends in LSD liquidity over the past months, as evidenced by the 2% Depth USD across both CEX and DEX markets.
LSTs 2% Depth USD
Although there are currently no signs of deteriorating liquidity, Gauntlet shares similar concerns regarding the future liquidity of LSDs. With LSD liquidity potentially shifting to restaking protocols, especially given the rapid growth in the space, and with increasing deposits in lending protocols, there could be downward pressure on liquidity. This shift may create a potential risk of manipulation for market price oracles moving forward, especially for lower liquidity LSDs like cbETH and rETH.
Liquid Restaking Tokens have been rapidly growing the past month and currently have $3.1B TVL
To address concerns about potential future low liquidity in the LSD markets, the community may consider implementing exchange rate-based oracles for LST assets within correlated Comet markets. Exchange rate-based oracles represent the rate for redeeming or staking assets via smart contracts, which market pricing does not influence. We have conducted a market risk analysis on market price and exchange rate oracles, that is detailed here. As mentioned in the original forum post, exchange rate oracles come with certain risks:
- Depegging Risk: In tail risk scenarios, there could be huge deviations in the smart contract rate and the market rate. During such events, the long queues for unstaking LSTs may prevent the smart contract rate and market rate to converge and lead to insolvent positions on the comet. Such deviations could happen in the case of mass slashing, technical risks (e.g. smart contract vulnerability), etc. It’s important to note that in these scenarios, despite the extreme price deviation between the market price and smart contract rate, liquidations would not occur, because the smart contract rate of the LST prices would remain the same.
- Manipulation Risk: The exchange rate contract faces a risk of exploitation, particularly when some exchange rate oracles are controlled by externally owned accounts (EOAs), making them vulnerable. This could result in the manipulation of exchange rates and potential loss of deposited base tokens.
If the community decides to pursue exchange rate oracles, preventive measures can be implemented to mitigate LST risks associated with price dislocation and EOA concerns:
- Severe Dislocation Mechanism: Protocols may implement measures, like halting new supplies or setting collateral factors (CF) to zero, to prevent an increase in LST supply during significant market dislocations, despite their rarity and unpredictability.
- Oracle Feed Threshold Mechanism: Implement a smart contract on the Oracle feed of all assets, particularly those dependent on exchange rate feeds, to prevent the price from exceeding a certain ratio. This strategy helps prevent potential upward price manipulation and protects protocol deposits.
In summary, we advise the community to carefully evaluate the pros and cons of exchange rate-based oracles and consider implementing risk-mitigation measures where necessary.