Summary
BA Labs & B. Protocol propose listing weETH/ETH market to the Moonwell Flagship ETH vault on Base to capture the yield and improve the overall vault APY, noting that due to asset risk profile, distribution, and lindyness built up, we consider it as blue-chip collateral at this point.
Proposed parameters for weETH are listed below.
Introduction
To date, Moonwell Flagship vaults, including the Flagship ETH vault, have had restricted listings to a very limited number of assets, including the largest and most lindy liquid staking tokens, which keeps the overall risk exposure of the market low compared to other Morpho vaults.
Here, we propose sticking to that kind of approach, with the goal of increasing the overall APY of Flagship ETH vault by considering adding the first LRT asset - etherfi’s weETH.
Rationale
Etherfi’s weETH is the largest and most liquid LRT on the market currently, with over $10 billion in TVL. Etherfi also stands out as the only large LRT with withdrawals fully enabled, which helps ensure stable liquidity and a strong peg vs underlying ETH. Given these features, and the historical higher borrowing rate compared to most liquid ETH market (wstETH/ETH) on the Morpho Base deployment, listing weETH offers an attractive growth opportunity to increase total ETH borrow utilization on the Moonwell Flagship ETH vault.
Risk Assessment
Technical Risk
Both Etherfi and Eigenlayer have gone through significant auditing and code review processes. Eigenlayer has undergone 4 audits plus an audit competition, while Etherfi has also undergone 4 audits plus an audit competition. Eigenlayer and Etherfi also offer bug bounty programs through Immunefi, with maximum payouts of $2 million and $200,000, respectively. While the auditing and bounty provisions are adequate, the maximum caps for bounties may be on the low end, considering the amount of value secured in the protocols. In each case, the maximum bounty payout is well below 0.01% of the protocols’ TVL.
Etherfi and Eigenlayer have both been operating without exploits or bugs for roughly over 2 years. Given the significant time-integrated TVL during this period, they have accrued a decent level of technical lindyness. However, each protocol has seen upgrades over this period particularly to support AVS, which opens up the possibility of bugs being introduced into the protocols. So we can only rely on historical time and TVL as evidence of security to a limited degree.
Validation and Slashing Risk
As a liquid restaking token, weETH is subject to validation risk and slashing conditions for not only Ethereum protocol staking, but also staking via Eigenlayer AVS. With slashing now live on EigenLayer, the risk landscape for LRTs is evolving, including EtherFi’s opt-in to secure AVSs like e.g. ETHGas marketplace. However, BA Labs assesses slashing risk as minimal under normal conditions, noting there have been no slashing events so far.
Redemptions
Etherfi stands out as the only large LRT to offer redemptions to ETH. This provides a key arbitrage mechanism in cases where weETH falls below the value of underlying ETH holdings, as users can buy up discounted weETH and then unstake. This is similar to other LSTs like stETH and rETH, where activation of redemptions has significantly improved their resilience and peg strength.
Eigenlayer introduces an additional 1 week withdrawal delay for restaked ETH, so we can expect that redemptions may provide somewhat lower price support for weETH versus traditional LSTs. Because of the additional Eigenlayer withdrawal delay, we estimate that fully withdrawing from weETH will take roughly 1 week longer than withdrawing from comparable LSTs like rETH or stETH. The result is that LRTs like weETH are likely to face larger discounts in a broad based market crash vs traditional LSTs like rETH and stETH, as the redemption arbitrage loop has a greater duration and therefore a lower yield to maturity for a given discount.
Market Risk and Liquidity
Most of the weETH liquidity on Base consolidates around Aerodrome v3 and Fluid pools, which currently account for ~80% of the route for a 500 weETH → WETH swap on Base, resulting in below 2% price impact.
Oracle Settings and Price Deviation Risk
weETH can be priced using live market pricing via oracle, or via exchange rate pricing as measured by the weETH to eETH ratio in the wrapping, considering eETH to be worth a fixed 1 ETH value based on redeemability. Aave currently uses an exchange rate pricing mechanism for weETH on their deployment, while Morpho uses live pricing.
Live pricing has the advantage of potentially liquidation positions earlier in a depeg, before the price of weETH potentially falls further, and can also better account for the possibility of permanent impairments due to technical or slashing losses. But on the other hand, this also creates additional risk of liquidating at excessively low prices during a flash crash, as liquidations and oracle updates can lead to a negative feedback loop of lower prices creating more selling pressure creating further price drops.
On balance, we believe using an exchange rate pricing mechanism rather than live oracle pricing is more appropriate for weETH. While the availability of redemptions may help reduce depeg risk, there is still a possibility of flash crashes occurring, as it can take some time for bidders to step in to purchase weETH below par and arbitrage redemptions, while liquidations can happen immediately. Using exchange rate pricing eliminates the risk of liquidating positions based on short-term price wicks, which can negatively impact UX and may even result in bad debt to the protocol, depending on how low the price falls temporarily.
However, using exchange rate pricing does create a few new risks. weETH trading at a discount to the exchange/redemption rate results in a higher effective liquidation threshold, as the fair market value of collateral will be lower than suggested by the protocol. And if the weETH discount is larger than the liquidation penalty for weETH collateral, this would halt the liquidation process as liquidating unsafe positions would no longer be profitable (the value of debt repaid would be greater than immediately achievable value of collateral received). weETH parameters such as liquidation threshold (LT), maximum loan to value ratio (LTV), and liquidation penalty should be set with this in mind to account for any reasonably foreseeable, persistent weETH price discounts.
Market Parameters
Loan token: WETH - 0x4200000000000000000000000000000000000006
Collateral token: weETH - 0x04C0599Ae5A44757c0af6F9eC3b93da8976c150A
Oracle: weETH/ETH exchange rate * eETH/ETH fixed at 1 - 0xcE629400c6AEdb64f087CAC40Ae6a382AEEef490
IRM: Adaptiv Curve IRM - 0x46415998764C29aB2a25CbeA6254146D50D22687
LLTV: 94.5%
Supply Cap: 5K WETH