Thread by @el33th4xor

I'm worried about the effect of high ETH fees on DeFi.

A quick thread on what can go wrong.

Recall that much of DeFi involves collateralized lending, where the borrowers 1. use high leverage, and 2. use the loaned amounts to buy into other crypto assets. It comes down to people providing X as collateral and buying Y.

Imagine that there's a modest-but-significant drop in crypto prices. If X drops relative to Y, for whatever reason, the collateral is insufficient, and liquidation mechanisms need to kick in.

On a good day, this is simple: people post additional collateral and continue their positions (post), or else they liquidate their position (exit).

But there are three complications that can make this a nightmare:

1. ETH fees are already very high
2. DeFi typically requires dozens of interactions on chain
3. The number of people who need to take action easily exceed the amount of blockspace.

And failure to take timely action can trigger positive (which is bad) feedback loops, where dropping prices causes fees to spike, making it difficult for people to post/exit, which causes liquidations, which cause the prices to decrease, and so on.

It's difficult to solve this. Fee management schemes, like our work (papers.ssrn.com/sol3/papers.cf…), are only a band-aid. They would reduce the fees, but when you have huge excess demand for block space, there isn't much that can be done.

Fundamentally, the only real solution here are faster, better chains. That's what we are working to deliver with @avalancheavax, as well as the efforts underway on eth2, and others.

In the super short term, there will be great opportunities to snipe on, and cheaply acquire, liquidated coins. Ideas such as @phildaian's Gas Token can help accomplish this at a time when gas fees are very high.

If you have not heard of Gas Token, look it up -- it allows people to arbitrage blockspace, by "banking" it when it's cheap, and turning it in and using it when fees are spiking.

Otherwise, if you're using DeFi, be ready to post/exit, and try not to use too much leverage to shield yourself from small downturns.