Why Elastic Supply is a Flawed Foundation for Money Market Collateral

Rebasing tokens break standard price oracles. A flash loan can temporarily inflate supply, manipulate the time-weighted average price (TWAP), and create risk-free arbitrage against undercollateralized loans.

• Attack Vector: Exploit the lag between supply change and oracle price update.
• Real-World Precedent: Similar to the Fei Protocol Rari Fuse exploit, where oracle manipulation led to $80M+ in losses.

During a negative rebase (contraction), a user's collateral value can shrink faster than their debt, pushing them underwater instantly. Liquidators are disincentivized as seized collateral continues to decay.

• Systemic Failure: Creates unliquidatable positions that poison the entire lending pool.
• Protocol Contagion: Seen in Tomb Fork collapses on Fantom, where TSHARE collateral imploded markets on Granary Finance and Geist Finance.

Elastic supply mechanics are opaque to integrated DeFi legos. A vault on Yearn or a leveraged farm on Abracadabra cannot accurately track a user's collateral balance across transactions, leading to silent insolvency.

• Integration Risk: Breaks the fundamental assumption of ERC-20 balance invariance.
• Silent Insolvency: Positions can become undercollateralized between block confirmations without any user action.

Primate protocols like Aave and Compound now relegate elastic tokens to isolated markets with 0 borrow cap. This contains the blast radius but admits the asset is unfit for general use.

• Risk Containment: Prevents contagion to core protocol reserves.
• Market Reality: Acknowledgment that rebasing tokens are speculative assets, not money.
• Superior Alternative: Overcollateralized stablecoins (DAI, LUSD) and real-world assets (RWAs) provide stable value without supply elasticity.

The original elastic supply token proved rebasing mechanics are fundamentally incompatible with DeFi collateral. Price volatility is replaced by supply volatility, creating unpredictable liquidation risks.

• TVL Collapse: From ~$1B+ at peak to near zero in DeFi lending pools.
• Oracle Manipulation: Rebase events create predictable, exploitable price feed lag.
• User Abandonment: Negative rebases act as a hidden tax, driving capital to stable assets.

The canonical case of reflexive collateral failure. UST's peg relied on arbitrage burning LUNA, creating a positive feedback loop that vaporized ~$40B in days.

• Reflexive Collateral: LUNA price drop weakened UST peg, which increased LUNA minting/selling pressure.
• Convexity Risk: The system's stability was inversely proportional to the stress it was under.
• Contagion: Collapse triggered a crypto-wide deleveraging event, bankrupting 3AC, Celsius.

The modern test: using staked ETH (stETH) and short futures to back a synthetic dollar. It substitutes supply elasticity with basis trade risk and custodial trust.

• Basis Risk: Negative funding rates can turn the promised ~30% APY into a liability.
• Centralized Points of Failure: Relies on CEXs for futures positions and off-chain custody.
• Procyclical Collateral: High demand for USDe increases short positions, amplifying systemic leverage in derivatives markets.

Money markets require predictable Loan-to-Value (LTV) ratios. Elastic or reflexive collateral has a non-stationary value function, making risk assessment impossible.

• Unhedgeable Risk: You cannot hedge against a rebase or a reflexive mint/burn mechanism.
• Oracle Dilemma: Should price reflect the token's market cap or its unit price? This ambiguity is fatal.
• Regulatory Poison: The Howey Test loves algorithms that promise returns based on others' work—elastic tokens are a securities lawyer's dream.

Elastic supply mechanics directly alter the token's total supply, creating a fundamental conflict with standard price oracles. An attacker can exploit the rebase to manipulate collateral value.

• Key Risk: A flash loan can temporarily inflate supply before a rebase snapshot, artificially boosting collateral value.
• Key Consequence: Allows borrowing against phantom value, leading to undercollateralized positions and bad debt.

Standard liquidation triggers based on price-to-debt ratios break when the collateral's quantity per wallet changes autonomously.

• Key Risk: A negative rebase can instantly push healthy positions below the liquidation threshold without any market price movement.
• Key Consequence: Causes mass, "unfair" liquidations or requires pausing the entire system during rebase events, killing composability.

Elastic supply tokens poison the DeFi stack. Their non-standard behavior breaks assumptions for integrators like Curve pools, Convex staking, or cross-chain bridges like LayerZero.

• Key Risk: Any protocol integrating the asset inherits its rebase complexity and risk, creating fragile, interdependent systems.
• Key Consequence: Limits adoption, increases integration overhead, and concentrates systemic risk. See the collapse of Terra's UST ecosystem.

Isolate the elastic token's mechanics from the core lending logic. Use wrapped, non-rebasing derivatives (e.g., stETH for ETH) as the actual collateral asset.

• Key Benefit: The lending protocol interacts only with a static-balance wrapper, using standard oracles and liquidation engines.
• Key Benefit: The rebase mechanics are handled upstream by the wrapper contract, converting supply changes into per-share price appreciation.

For direct integration, bypass supply-based pricing. Use a custom oracle that tracks the price-per-share of the elastic token, not the market cap divided by fluctuating supply.

• Key Benefit: Reflects the true economic value of a user's deposit, neutralizing rebase-based manipulation.
• Key Benefit: Enables accurate health calculations for liquidation. Adopted by protocols like Aave for staked assets.

If you must use elastic collateral, apply extreme risk parameters. Treat it as a volatile, experimental asset class.

• Key Benefit: High Loan-to-Value ratios (e.g., 50% or lower) and strict debt caps limit the protocol's exposure to any single failure.
• Key Benefit: Creates a buffer against oracle inaccuracies and sudden supply contractions, protecting the protocol's solvency.