I’ve noticed that ShezmuUSD, a stablecoin by Shezmu, has recently been added to the core pool of Balancer. This prompted me to take a closer look at their protocol, and I quickly identified some red flags. The majority of their stablecoin supply (around 500K out of 667K) is issued against their own NFT, which is itself issued by locking up their own token. This setup immediately raised concerns for me, as it reminds me of the issues we saw with old USDM.
Digging further, I came across a wallet (0x38B6C456Cb66A0AbCf604b6E1E0B0eE7DD988b87) that appears to belong to the Shezmu team. This wallet is used for their buybacks and currently holds around 300K of ShezmuUSD debt, which is already past the liquidation price. When I reached out to their Telegram group for clarification, they assured me that this wallet is used for buybacks and that there’s nothing to worry about. However, I remain concerned.
Currently, ShezmuUSD is trading above its peg, and the promise of high yields has attracted many users. But from what I can see, there doesn’t seem to be enough backing assets, which could be risky for the Balancer community. Given these concerns, I believe we should seriously consider whether it’s in Balancer’s best interest to continue supporting this gauge—or if it might be wiser to remove it before it potentially becomes a liability.
What do you all think? Should we kill the gauge or not?
What is worth noting is that both pools have very low native token (shezUSD and shezETH) liquidity.
As a general reminder, pools are marked as core pools if 50% of their assets are yield-bearing and exceed $100k in TVL of which both pools are eligible to. The core pool list is generated weekly automatically through the Maxis operations tooling.
@Shezmu could you provide some context to the concerns raised by @manawenuz ?
I see that the team has increased the ceiling on their NFTs aswell, the pain in the end is just gonna be more and more, as time goes by, any participation in discourse is really appreciated.
right now there is 525K shezusd debt backed by pharoah NFTs , in addition to that 75 shezETH backed by NFTs, basically the debt has balooned to around 700K.
We understand the concerns raised about ShezmuUSD and its structure, particularly around how it’s collateralized with NFTs and tokens from within the ecosystem. Here’s a breakdown to address the key points and provide reassurance:
1. Soft Liquidation Process Through NFT Auction
Misconception of a Death Spiral:
The liquidation process of ShezmuUSD is designed to avoid a death spiral, unlike traditional liquidations that result in rapid sell-offs and subsequent market crashes.
NFT-backed liquidation functions more like a soft liquidation via auction, meaning when collateral falls below the required ratio, it doesn’t instantly get dumped into the market.
Instead, collateralized NFTs are auctioned, allowing for gradual liquidation. This auction mechanism gives the market time to absorb the assets, reducing the risk of a market shock or rapid devaluation.
Auction-based Liquidation:
This model ensures more orderly liquidations and allows buyers to step in at multiple stages, ensuring there is always sufficient backing for ShezmuUSD and avoiding a sudden collapse in value or liquidity drain.
Comparison to USDM:
While old models like USDM failed due to the rapid collapse of collateral, our liquidation mechanism was specifically designed to prevent this. It emphasizes capital recovery rather than fire sales, reducing systemic risk.
2. Capital Efficiency via Pharaohs
Boosting Efficiency:
The protocol uses Pharaohs with a collateralization ratio (C-ratio) of 166%, which allows users to unlock more borrowing power. In contrast, other assets are required to maintain a C-ratio of 125%.
This structured system allows the platform to maintain a healthy aggregate collateralization ratio (above 150%), ensuring robust capital backing.
Strengthening Resilience:
This setup ensures that even when users borrow against their collateral, the overall platform C-ratio remains above the threshold, preventing sudden liquidity crunches.
Pharaohs increase capital efficiency while ensuring that the system remains well-capitalized. Even if some assets underperform, the protocol can maintain solvency and protect the ShezmuUSD peg.
Risk Management with Pharaohs:
If the platform collateralization ratio (C-ratio) drops below 150%, borrowing from Pharaoh markets is paused until the ratio is restored. This helps safeguard the stability of the entire protocol.
3. Protocol Revenue and Stability
Consistent Revenue Streams:
The protocol generates around $250K per month from fees, bonds, interest, and other inflows. This consistent revenue base ensures that ShezmuUSD is well-capitalized and capable of handling any debt obligations that may arise.
Risk Mitigation Plan:
If required, the protocol could clear $300K of debt within 2 months, without drawing from existing treasury assets, thanks to steady revenue streams.
This means that even if some wallets approach liquidation, the protocol has enough income and collateral to address the situation without causing a market shock or destabilizing the ShezmuUSD peg.
4. Addressing the Specific Wallet Concern
Buyback Wallet Clarification:
The wallet holding ShezmuUSD debt is part of the protocol’s buyback mechanism. It plays a crucial role in managing liquidity and price stability.
Buybacks help maintain ShezmuUSD’s peg and ensure that liquidity remains stable, preventing significant deviations from the intended value.
Strategic Role of Buybacks:
While the debt held by this wallet may seem concerning at first glance, it’s part of a broader strategy to stabilize the platform and its assets, mitigating risks and maintaining a healthy liquidity environment.
5. Backing Assets and Over-collateralization
Sufficient Backing:
ShezmuUSD is over-collateralized through a combination of NFTs, tokens, and other assets. With Pharaohs maintaining a C-ratio of 166% and other assets at 125%, the aggregate platform C-ratio is well above the minimum threshold, ensuring strong backing.
Here is a hypothetical Example of a Liquidation Scenario with a Pharaoh:
1. User A borrows ShezmuUSD using a Pharaoh as collateral:
The platform-wide C-ratio is 150%, but for Pharaohs, the C-ratio is set at 166%.
User A’s Pharaoh is worth $100,000, allowing them to borrow up to $60,241 ShezmuUSD (66.67% of the collateral value, keeping the C-ratio above 166%).
2. Triggering Liquidation:
The value of the Pharaoh drops to $90,000, lowering User A’s C-ratio below 166%.
This triggers a soft liquidation via the auction process.
3. Auction Process:
Instead of instantly liquidating, User A’s Pharaoh is moved to auction, giving bidders time to purchase the collateral at a fair market price.
4. Treasury Participation:
The Shezmu treasury can choose to participate in the auction, placing bids to potentially acquire the Pharaoh if it sees strategic value in holding the asset.
If the treasury places the winning bid, it would then hold the Pharaoh, adding to the protocol’s collateral reserves.
5. Other Buyers:
If other bidders win the auction, they purchase the Pharaoh at the final auction price, and the proceeds from the sale are used to repay User A’s debt.
6. Repaying the Debt:
Let’s say the Pharaoh is auctioned for $85,000.
The $85,000 is used to repay User A’s $60,241 debt, with the remaining $24,759 going back to User A after the debt is cleared.
7. Market Stability:
Regardless of whether the treasury or external participants win the auction, the liquidation process ensures that the debt is covered without causing significant market disruption.
If the treasury wins, it strengthens the protocol’s reserves by holding the asset; if not, the debt is still repaid, maintaining system solvency.
This system prevents a sudden market collapse while maintaining sufficient capital to cover liabilities and stabilize ShezmuUSD.
A little on the Pharaoh creation process and choice of collateral:
Pharaohs Creation:
Pharaohs are minted when the protocol buys and burns the native Shezmu token from the open market. This process not only creates significant buy pressure on Shezmu, but also strengthens the platform by simultaneously increasing the overall collateralization ratio.
Collateral Strategy:
The protocol intentionally uses Pharaohs as collateral because the process of buying and burning Shezmu brings the three benefits of both stabilizing the token’s price and improving the protocol’s health by boosting the system’s collateralization and improving APR’s for LPs.
While the protocol could utilize other assets like sfrxETH or weETH, which offer more favorable Loan-to-Value (LTV) ratios and lower liquidation risk, the decision to use Pharaohs as collateral prioritizes the benefit of sustained buy pressure on Shezmu, which outweighs the advantages of borrowing against other whitelisted assets.
Alternative Assets:
Assets such as sfrxETH and weETH are still part of the protocol’s collateral pool. They come with lower liquidation risk and more favorable LTVs, making them ideal for risk management. However, the protocol prefers to utilize Pharaohs, as the buy and burn mechanism benefits the platform’s long-term stability and aligns incentives with users.
TLDR:
The concern is appreciated.
Soft liquidations via auction prevent a death spiral, as collateral is gradually auctioned until the collateralization ratio is restored.
The treasury can cover debt immediately if needed, and protocol fees can cover it within two months.
The protocol can use other assets like sfrxETH or weETH to put users at ease, offering more favorable terms and reducing risk.
On Friday the 20th of September 2024, the Shezmu protocol was hacked. In a first wave, shezUSD was drained by an infinite minting attack. Balancer Maxis took immediate action and paused the shezETH pool which prevented the pool to be used as exit liquidity as a pause disables trading. We furthermore put the pool now into recovery mode which enables users to withdraw but not join the pool.
The shezmu team froze shezETH, meaning at this time that asset is not tradeable.
Thanks again @manawenuz for bringing concerns forward although this incident is not related to bad debt. Given this incident, we will prepare a proposal to remove all relevant shezmu gauges from the veBAL system immediately.
