Circle Economist Proposes 50% Rate Ceiling to Snap Aave’s USDC Liquidity Crisis

An economist at USDC issuer Circle proposed an emergency overhaul of Aave’s lending mechanics on Wednesday, calling for a massive interest rate hike to break a liquidity crunch that has left users’ funds trapped on the lending protocol for the past five days.

After users borrowed massive amounts of stablecoins to escape fallout associated with Kelp DAO’s recent $291 million exploit, quadrupling the maximum interest rate on Aave should shock the system back into balance, according to Circle Chief Economist and Head of Research Gordon Liao.

Under the proposal, the maximum borrowing rate for USDC on Aave could rise as high as 50%, incentivizing users to repay debt and making the lending protocol an “irresistible destination” for capital that would enable depositors to have a better chance of withdrawing funds, he wrote.

With borrowing costs currently capped at a rate of 14%, Liao indicated the cost of capital remains low enough that users are opting to keep positions open instead of repaying their debt. The so-called utilization rate for USDC has meanwhile been pinned around 100% since Sunday, signaling that liquidity for lenders has effectively dried up, according to Aavescan.

Liao’s proposal reflects widespread and ongoing efforts to address the liquidity crunch that has shaken confidence in decentralized finance and prompted users to yank $12 billion in digital assets from the sector’s most battle-tested protocol in a handful of days. As of Thursday, Aave’s protocol held around $15.47 billion in total assets.

Beyond letting rates rise, Liao’s proposal seeks to lower the “optimal” utilization rate for USDC on Aave to 85% from 92%. The lower mark would reduce the threshold at which borrowing costs steepen for users, a move aimed at creating a sustainable cash buffer for withdrawals.

Liao noted that his proposal only reflects his personal views, yet the suggestion was amplified by Circle co-founder and CEO Jeremy Allaire in an X post on Thursday.

Many users who borrowed stablecoins on Aave did so because they were unable to withdraw Ethereum from the platform. That is because the attackers that plundered $292 million in crypto from Kelp DAO used the stolen funds to borrow assets from the lending platform.

Allowing borrowing rates to quadruple for USDC might alleviate the crisis, but some members of Aave’s governance forum pushed back against the proposal, fearing changes could stoke liquidations among those affected as positions become prohibitively expensive.

Earlier this week, the security council overseeing Arbitrum effectively froze 30,766 Ethereum valued at $71 million, which attackers had moved to the layer-2 scaling network, reducing the haircut that Aave users could face if losses from the Kelp DAO exploit are socialized.

DeFi projects like Lido are also in a position to support Aave. On Thursday, the liquid staking protocol, which allows users to earn rewards without locking their tokens up, received a proposal that floated a one-time contribution of up to 2,500 stETH to a dedicated relief vehicle.

“The proposal is designed to reduce broader ecosystem spillover and support an orderly resolution for affected users,” Lido said in an X post.

On Saturday, attackers drained 116,000 rsETH from a cross-chain bridge that allows users to move the token, which is backed by staked Ethereum, from one network to another. Issued by Kelp DAO, rsETH functions as a tradeable “receipt” for the DeFi protocol’s depositors. 

The bridge was built on infrastructure from interoperability protocol LayerZero, which subsequently blamed Kelp DAO for relying on what has been described as a single point of failure. Kelp DAO pointed the finger back at LayerZero, arguing that only LayerZero’s systems were impacted by the attack, which has since been linked to North Korea’s Lazarus Group.