Survive the Bear Market: Retail Investor Strategies for the Arrival of Low-Risk DeFi

Author: Zuo Ye

The direct triggers of the events on October 11 and November 3 were not yield-bearing stablecoins, but they dramatically struck USDe and xUSD in succession. Aave hard-coded USDe to peg to USDT, preventing the on-site crisis at Binance from spreading to the blockchain, and Ethena's own minting/redemption mechanism was also unaffected.

However, the same hard coding has caused xUSD to be unable to directly collapse, falling into a long period of garbage time, where the issuer Stream's bad debts cannot be cleared in a timely manner, and related party Elixir and its YBS (yield-bearing stablecoin) product deUSD are also under scrutiny.

In addition, multiple Curators on Euler and Morpho accept xUSD assets, and user assets randomly explode in various Vaults, lacking the emergency response role of the Federal Reserve in SVB, leading to a potential liquidity crisis.

Let a single point of crisis amplify into an industry upheaval, as xUSD crosses over the fallen principal, waging war towards eternity.

Manager + Leverage, the source of crisis?

It is not the leverage that caused the crisis, but the private agreements between protocols that led to a lack of transparency, lowering users' psychological defense thresholds.

During a crisis, the following two points of understanding constitute the basis for the division of responsibilities:

1. The insufficient issuance of xUSD from the leverage cycle of Stream and Elixir is primarily due to the management teams of both parties.

2. Curated Markets of lending platforms like Euler/Morpho accept “toxic assets” xUSD, and the platform and the curator should bear joint liability;

We will first reserve our views to gain insight into the operational mechanism of YBS. Compared to the operational logic of USDT/USDC, where dollars (including U.S. Treasury bonds) are deposited in banks, and Tether/Circle mint equivalent stablecoins, Tether/Circle earns interest on deposits or government bonds. The usage of stablecoins inversely supports the profit margins of Tether/Circle.

The operational logic of YBS is somewhat different; theoretically, it adopts an over-collateralization mechanism, which means that for every $1 stablecoin issued, collateral in excess of $1 is required. This collateral is then invested in DeFi protocols to earn returns, which are distributed to holders, while the remaining amount constitutes its own profit, which is the essence of its earnings.

Image description: YBS minting, earning, and redemption process

Image source: @zuoyeweb3

Theory is not reality. Under the pressure of high interest rates, the YBS project team has developed three “cheating” methods to enhance its profitability:

1. Transforming the over-collateralization mechanism into under-collateralization is foolish as it directly reduces the value of the collateral and is unlikely to be effective; however, corresponding strategies are also evolving:

• A mixed support of “expensive” and “cheap” assets, with US dollar cash (including US Treasuries) being the safest, BTC/ETH also relatively safe, but TRX is also supporting USDD, which discounts its value.

• On-chain/off-chain asset mixing support, this is not a bug, but a form of time arbitrage, ensuring that assets are in their corresponding positions during audits. Most YBS will adopt such mechanisms, so no separate examples are provided.

2. Enhance leverage capability. After YBS is minted, it will be投入 into DeFi protocols, mainly various lending platforms, and it is best to mix with mainstream assets such as USDC/ETH.

• Magnify the leverage multiplier to the extreme, using 1 dollar as if it were 100 dollars, the potential profits may be greater. For example, the cyclical loan created by the combination of Ethena and Aave/Pendle can achieve approximately 4.6x Supply leverage and 3.6x Borrow leverage with a conservative cycle of 5 times.

• Use less capital to leverage, for example, Curve's Yield Basis once planned to directly issue crvUSD, in fact reducing the amount of capital utilized for leverage.

Therefore, xUSD has implemented a series of strategies, leveraging upfront and circular issuance, which is essentially the version mechanism of xUSD. Observing the above image, YBS will enter the profit “strategy” after minting, which is essentially the process of increasing leverage. However, xUSD and deUSD work together to migrate it to the issuance process, so users can see both the excess collateral ratio and the profit strategy. But this is entirely a smokescreen by Stream, where Stream acts as both the referee and the athlete, making xUSD an under-collateralized YBS.

xUSD uses leverage in the second step to issue more in the first step, relying on Elixir's deUSD to leverage about 4 times, which is not considered large. The problem lies in the fact that 60% of the issuance is controlled by Stream itself. When making a profit, the profits will also be retained by itself, and when there is a crash, the bad debts are also its own, making it impossible to realize the most important socialization of losses in the liquidation mechanism.

The question is why Stream and Elixir want to do this?

In fact, direct collusion between protocols is no longer news. When Ethena introduced CEX capital, it gained partial exemption rights during ADL liquidation. Returning to xUSD, among the responses from various vault managers, Re7 was the most interesting: “We recognized the risks, but at the strong request of users, we still listed it.”

Image description: Re7 response

Image source: @Re7Labs

In fact, the treasury managers of platforms like Euler/Morpho can definitely identify the issues with YBS, but under the pressure of APY and profit demands, some will actively or passively accept it. Stream does not need to convince all managers; it just needs not to be rejected by everyone.

The operators who accept xUSD definitely have responsibilities, but this is a process of survival of the fittest. Aave was not built in a day; it has grown into Aave through continuous crises. Would relying solely on Aave make the market safer?

In fact, it won't. If there is a lending platform like Aave in the market, then Aave will become the sole source of systemic crisis.

Platforms like Euler/Morpho represent a decentralized market or a “new third board” mechanism, which offers more flexible allocation strategies and lower entry barriers, playing a significant role in the popularization of DeFi.

But the problem remains opaque; the curator of Euler/Morpho essentially allows the existence of third-party sellers, while Aave/Fluid is completely self-operated like JD.com. Therefore, interacting with Aave means Aave is responsible for security, but part of Euler's treasury is managed by the curator, and the platform intentionally or unintentionally blurs this point.

In other words, platforms like Euler/Morpho have lowered users' defense and due diligence expectations. If the platform were to adopt a friendly fork like Aave or a liquidity backend aggregation like HL, while maintaining absolute separation in the frontend and branding, it would face much fewer accusations.

How should retail investors protect themselves?

The end of every DeFi dream is ringing the bell for retail investors.

As a major blockchain supporting DeFi, Vitalik is not particularly fond of DeFi. He has long advocated for non-financial innovations to occur on Ethereum. However, he genuinely cares for retail investors. Since DeFi cannot be eliminated, he has begun to call for Low Risk DeFi to empower the world's poor.

Image description: DeFi and the real world in Vitalik's eyes

Image source: @zuoyeweb3

Unfortunately, what he fantasized about was never a reality, and people have long believed that DeFi is a high-risk and high-reward product. In 2020, during the DeFi Summer, this was indeed the case, with yields exceeding 100%. However, now even a 10% return is suspected to be a Ponzi scheme.

The bad news is that there are no high returns, the good news is that there are no high risks.

Image description: Ethereum loss rate

Image source: @VitalikButerin

Whether it is the data provided by Vitalik or that from more specialized research institutions, the level of security in DeFi is indeed increasing. Compared to the liquidation data of 1011 Binance and the huge thefts on Bybit, the explosions and losses in DeFi, especially those of YBS, are negligible.

But! I have to say but, this does not mean we should be at ease with DeFi, as CEX becomes increasingly transparent, but DeFi becomes increasingly opaque.

The era of regulatory arbitrage for CEX has ended, but the era of relaxed regulation for DeFi has returned. This certainly has its benefits, but what is called DeFi is increasingly centralized in reality, with too many undisclosed terms hidden between protocols and between the main operators.

What we thought was on-chain cooperation is actually the commission rate of TG. This time, many project leaders of xUSD released TG screenshots, and their decisions will directly affect the future of retail investors.

The regulatory requirements mean little to them; the core is still to combine usable modules from the chain. Don't forget that over-collateralization, PSM, x*y=k, and Health Factor are sufficient to support the macro activities of DeFi.

In 2025, the entire Yield supported by YBS consists of the following: YBS assets, leveraged Yield strategies, and lending protocols, which are not too many to count, such as Aave/Morpho/Euler/Fluid and Pendle meeting 80% of interaction needs.

Opaque management leads to strategy failure, and the manager has not demonstrated superior strategy setting ability; the elimination process must occur after each problem.

Apart from this, what retail investors can do is to penetrate everything, but frankly speaking, this is not easy. Both xUSD and deUSD are theoretically over-collateralized, but the mixing of the two brings the leverage process that should occur after minting forward to the minting stage, resulting in xUSD not actually being over-collateralized.

When YBS is minted based on another YBS, it becomes very difficult to distinguish the collateral rate after iteration.

Before the emergence of products that penetrate everything, retail investors can only rely on the following belief to protect themselves:

1. Systemic crises are not crises (socialized), participating in mainstream DeFi products assumes safety, but unsafe moments are unpredictable and unavoidable. The problems with Aave can indicate the decline or reboot of DeFi.

2. Do not rely on KOLs/media; participating in a project is a subjective choice (all judgments are our own thoughts). The information is just a reminder that “this product exists”. Regardless of KOL reminders, alerts, calls, or DYOR disclaimers, one ultimately needs to make their own judgment. Professional traders shouldn't even look at news, but should rely solely on data for decision-making.

3. Pursuing high returns is not riskier than low-return products; this is a counterintuitive judgment that can be viewed through Bayesian thinking. High returns do not necessarily mean a high risk of failure, and the risk is quite low. Low returns do not indicate a high risk of failure, but the risk is quite large. However, we cannot quantify the ratio of the two, that is, derive the odds; more simply put, the two are independent events.

Correct our beliefs with external data, not seek data support for our beliefs.

Moreover, there is no need to overly worry about the market's self-repairing ability. It is not retail investors who pursue volatility returns, but rather capital that seeks liquidity. When all capital retreats to Bitcoin or USDT/USDC standards, the market will automatically induce them to pursue volatility, that is, stability will create new volatility. The volatility crisis triggers a pursuit of stability.

You can take a look at the history of negative interest rates; liquidity is the eternal buzz of finance, and volatility and stability are two sides of the same coin.

Conclusion

Retail investors in the upcoming YBS market need to do two things:

1. Seek data, data that penetrates everything, penetrating leverage and reserves; transparent data does not lie, do not rely on opinions to assess facts;

2. Embrace strategies, the cycle of leveraging/de-leveraging continues endlessly, simply reducing leverage does not ensure safety, always ensure that your strategy includes exit costs;

3. Control losses; while the loss ratio cannot be controlled, you can set your own psychological position based on points 1 and 2, and take responsibility for your own understanding.