Risk of Black Swan Event Could End DeFi? A Look into CRV Liquidity Crisis

Concerns are being raised over the lack of liquidity to sell a substantial amount of Curve DAO Token (CRV), creating the risk of what some experts are referring to as a potential black swan event, outlined in a thread by OlimpioCrypto on Twitter.

There’s a risk of a black swan event in DeFi.

As per Defillama, if CRV drops below $0.37, there’s 300M CRV to liquidate in Aave -most from Curve’s founder

The problem? There’s not a single Exchange or DeFi protocol where one can sell such a large CRV amount.

Risks explained 🧵 pic.twitter.com/Ug12IsJ3et

— olimpio (@OlimpioCrypto) July 31, 2023

A black swan event would typically represent a sudden and unforeseen market occurrence that could cause a severe impact on prices, market stability or the crypto ecosystem as a whole.

The issue arises from the possibility of CRV dropping below $0.37, leading to the liquidation of 300M CRV in Aave – most from Curve’s founder, according to Defillama.

Curve’s founder staked 300M CRV as collateral in other lending protocols like Aave and borrowed 60M USDT. This approach was chosen instead of market dumping, as selling 60M worth of CRV in the open market would cause the price to crash.

7/13

So the question remains, how are you going to liquidate 300M of CRV in Aave if price drops below 0.37?

The answer is: you can’t. At the moment, liquidity is not there.

If you cannot liquidate a position, then the protocol is left with bad debt.

What is bad debt?

— olimpio (@OlimpioCrypto) July 31, 2023

Curve’s situation has been exacerbated by a recent vulnerability in Vyper that allowed hackers to exploit some Curve pools. This occurrence caused CRV’s price to crash, bringing loans that were considered healthy even closer to the liquidation price.

Lachlan Feeney, founder and CEO of Labrys, Australia’s largest on-shore blockchain and Web3 studio, told Crypto Briefing:

“The price of the CRV token has fallen rapidly and interest rates are spiking due to lenders fleeing the ecosystem as they attempt to de-risk. All of this is lowering the value of Egorov’s collateral, pushing it closer and closer towards liquidation.”

The limited availability of CRV liquidity across decentralized and centralized exchanges, such as Binance and OKX, compounds the issue. This raises questions about how 300M CRV would be liquidated in Aave if the price falls below the critical threshold.

However, there is no single exchange or DeFi protocol where such a large amount of CRV can be sold.

The DeFi community is actively working to address this matter, with both Curve and Aave collaborating to find solutions. Feeney further clarified:

“Should liquidation of the debt actually be required, there is simply not enough liquidity in the system to facilitate a forced sale of $110m CRV tokens, forcing bad debt onto the lending platforms.”

While a black swan event is not deemed the most likely outcome, the non-zero risk has prompted urgent action:

“If one protocol starts liquidating assets there is a significant risk of cascading liquidations across the DeFi space. At this stage the community is hoping to avoid any liquidations from starting.”

Curve getting exploited. Risk of bad debt and liquidations in the ecosystem.

This might seems like an “it’s over” moment, but perhaps it’s just this cycles Black Thursday – the last crash before the bull market, with everything coming back 100x stronger

— Rune (@RuneKek) July 31, 2023