Margin Loans
Covenant enables margin lending against ERC20 tokens (e.g., LST tokens)
Mark-to-Market Liquidations
Margin loans are defined by having mark-to-market (MTM) liquidations against liquid collateral. The maximum loan that can be issued is determined by Loan-To-Value (LTV) thresholds, and liquidations are determined by Liquidation LTVs.
For example, a debt market might enable loans up to 80% LTV, and, if the LTV of the borrower's position exceed 90%, then be subject to liquidations. Covenant liquidations for mark-to-market (margin) debt are further details in the Liquidations section.
LST Margin Loan Example
Ethereum’s staking rate is considered by many to be the closest thing in crypto to a risk free rate of return, and liquid staking is one of the few markets that has grown in the bear market. Most users interested in this market passively stake their ETH, without leverage, and accept the base staking rate. A trade long popular among more sophisticated actors is to increase this yield by ‘folding,’ whereby...
wstETH (or some other liquid staking wrapper) is deposited into a lending protocol
ETH is borrowed
ETH is staked, giving the user wstETH
wstETH is deposited into lending protocol
Repeat until risk tolerance is reached…
As the popularity of liquid staking has grown, the rate of return has decreased. This rate of return is out of users’ control. Therefore, to sustain the profitability of this trade, users must optimize for the ETH borrow rate in step 2, above. Here, they do have a choice, as there are many lending protocols, with varying rates. A snapshot from September shows the stETH staking rate at 3.6% and protocol ETH borrow rates respectively at…
| Lending Protocol | ETH Borrow Rate | Max LTV |
|---|---|---|
Aave V3 Optimized | 3.56% | 90% |
GearBox | 3.29% | 90% |
Morpho Aave V3 | 3.23% | 90% |
Tazz Beta on Arbitrum | 3.00% | 95% |
Ignoring s***-coin borrow incentives, which were 0% across the board at the time of this snapshot, as well as the wstETH lend rate, which was also 0% for all protocols, the formula for calculating stETH-ETH folding yield for a given lending protocol is...
(stETH Yield - LTV*ETH Borrow Rate) / (1 - LTV)
Plugging in the 3.6% stETH yield and the numbers in the above table produce folding yields of...
| Lending Protocol | ETH Borrow Rate | 90% LTV Max Folding |
|---|---|---|
Aave V3 Optimized | 3.56% | 3.96% |
GearBox | 3.29% | 6.39% |
Morpho Aave V3 | 3.23% | 6.93% |
Tazz Beta on Arbitrum | 3.00% | 15% |
Covenant takes the cake here, with a higher max LTV of 95%, and each basis point decrease in the ETH borrow rate leads to around an order of magnitude improvement in folding yield. Decrease your borrow rate by 20 bps, increase your folding yield by 200 bps. While Morpho has yields competitive with Covenant, that's only if you're matched with a counter-party, and the gas fees often negate any efficiency gains.
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