ARC: Aavenomics quarterly upgrade

ARC rationale

On the 25th of September 2020, with the results of AIP-1, the Aave protocol kickstarted its initial phase of Aavenomics and Safety Incentives with a scheduled distribution of 400 AAVE per day to Safety module stakers.

With the implementation of the Aave Protocol V2 and the soft deadline of first-quarter approaching, the opportunity to upgrade the current Safety Incentives for a new quarter is here.

This ARC is inspired by the previous community-led discussions on the topic and the Aavenomics proposal with the objective to gather community sentiment and consensus to form and publish a formal AIP proposal vote for a community vote.

This ARC will increase the responsibility of AAVE stakers for their service of protecting the Aave protocol by the formal activation of the slashing.

The slashing officially enforces the currently implicit responsibility and risk of the participation in the stakings modules of Aave. In the worst-case scenario of critical failure, an amount to be decided will be slashed from stakers deposits.

In this phase 0 of the slashing, the auction mechanism will not be automatized yet and if a slash were to happen it would be done through governance and direct compensation.

This ARC will also enable Balancer Pool Token staking in the Safety Module.

To be discussed and decided :

  • Activation and reward for the Balancer Pool Token Staking (80/20 AAVE/ETH) : The BPT stakers will suffer a minimal impermanent loss due to the 80/20 ratio of the pool.
    They will also receive BAL tokens as part of the balancer ecosystem liquidity mining.
    They are also exposed to the same slashing risk as plain AAVE stakers.
    Regarding the AAVE safety incentive for BPT staker, we propose to share on an equal basis, 50/50 with the plain AAVE stakers.

  • Increasing the Safety Incentives: As the possibility of slashing will now be formally introduced, staking reward should reflect the risk. Hence we propose to increase the Safety Incentives to 550 AAVE per day

  • Slashing %: The original proposal by the Aave genesis team was 30% of the stake. We propose to keep it that way but it’s still up for discussion.

In terms of timeframe, the AIP-1 plan was enabled on 25th Sep 2020 with a non-binding deadline of 90 days. If community discussions and subsequent AIP vote fail to reach consensus on 24th December 2020; the current safety incentives plan will continue until a new AIP is voted on, or the Ecosystem reserves run out of funds.

ARC content in short

  • Activation of the Slashing for the Safety Module with a maximum slashing threshold at 30% of Staked Amount
  • Activation of the Balancer Smart Pool 80/20 AAVE/ETH (BPT)
  • Increase the Safety Incentives for AAVE staking to 550 AAVE per day and start the Safety Incentives for BPT staking at 550 AAVE per day. The new total staking reward will be 1100 AAVE per day.

Relevant Links

18 Likes

I think this is an important step moving forwards.

Assuming responsibility for adjusting risk parameters is essential for a safe, secure and efficient protocol. In-built depositor insurance is also an incredible new innovation in the space, and seeing it come to fruition is exciting!

I totally agree with the 50/50 reward split with plain stkAAVE stakers. Initially I had considered (and written a now-erased example) about whether or not we should reward staking on a value-denominated basis, but after consideration I believe allowing market forces to do their thing is a better option.

As for increasing the emission rate, I’m 100% on the same page. However, I do think we should look at this as a bootstrapping the safety module until governance eventually decides on long-term incentivization for stakers.

I would love to see the AAVE reserve eventually used for other purposes!

One point of contention is that there is only one option for providing insurance on Aave as of now, i.e: people cannot choose their risk/reward profiles. As time goes on, I’m looking forward to seeing and participating in discussions about risk tranching and separating risk between markets.

This is an exciting time to be a part of the future of finance!

12 Likes

So team AAVE can reap all the rewards from transaction fees, but if the protocol fails they will push all blame onto stakers and take stakers funds to pay for the damages. Seems legit

All point very well articulated. I agree with you. Thank you for voicing your opinions. I am actively supporting the network with my stake. These are crazy exciting times. So glad to see the evolution of finance away from draconian fiat.

1 Like

More DEX liquidity makes the AAVE token safer to use and accept as collateral - easier to liquidate with less slippage. I think this will have a beneficial effect on Aave’s existing loan portfolio, which has a decent amount of loans backed by AAVE collateral.

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Hey, there may be some confusion here but just to clarify, while staking does come with risk for the staker in the event of a shortfall (which is exactly why they’re rewarded for it), these ‘fees’ do not get sent to the Aave team as you have suggested.

All fees taken are put into the collector contract which is fully controlled and governed by Aave’s governance, so they are definitely not all being reaped by the team. This is further explained in the original Aavenomics here: https://docs.aave.com/aavenomics/

3 Likes

This is amazing to see what Aave accomplished so far, and i’m really excited about the future !

I totally support the slashing activation and the Balancer pool.
One thing i missed on the first proposal was the slashing for LP too, this is why the split is quite unbalanced in the ARC “Fees & Rewards”.

Considering slashing for LP, i’m for the 50/50 between stakers and LP, however, i do believe that we could increase the E.R to 2000 AAVE/day.

As mentioned above by @Zer0dot, the ecosystem reserve should also be used for other purposes like grants or rewards community members that are building on top of Aave.

I’m working with @EmmanuelD on an update of the ARC Fees & Rewards to rectify some points and take previous discussions in consideration.

8 Likes

This post was part of the Delphi Daily released today, in which I introduced this ARC to our community of readers and shared my take on it.


Given that the main role of the SM within the Aave ecosystem is to serve as an insurance fund in case of a shortfall event, it is obvious why slashing is necessary; without it, the SM would serve no function. Thus, my comments will focus on the more nuanced second point of the ARC: introducing BPT to the SM. Concretely, I will argue why this ARC is a first step towards making the SM more robust and better suited to handle shortfall events.

Let’s first speculate on what a shortfall event could mean for the price of AAVE. As I see it, there could be three main drivers of price action given a platform deficit (the numbering doesn’t imply chronological order):

  1. Price gets hit as trust in the platform is questioned. Selling within this group would be more long-term and fundamentals oriented from investors that get disenchanted with the brand.

  2. Price declines as sellers try to front run selling from group 1, the upcoming liquidation event of the SM and potentially the minting (and selling) of new AAVE tokens if the SM can’t cover the whole deficit.

  3. As price declines because of the previous points, a higher share of the SM needs to be liquidated to cover the losses of the shortfall event. This can even get to the point where the SM can’t cover the losses and additional minting and selling of AAVE tokens would be required.

The most dangerous aspect of the previous scenario is that a vicious cycle can emerge from the dynamic between points 2 and 3. As price declines as a product of points 1 and 2, a higher share of the SM needs to be liquidated, which in turn can exacerbate more selling from group 2, which would imply that an even higher share of the SM would need to be liquidated and so on (see next figure). The higher the share of AAVE held by the SM, the more powerful this dynamic can become.


Figure 1. Shortfall Effect on Price.

Even though it is impossible to estimate what the precise effect on price a shortfall event could have on AAVE, we can look into the recent past for some hints. The next figure shows price evolution from different DeFi projects since they were hacked. Two important facts are worth noting from that graph: 1) Token prices have been aggressively hit (-18 to -53%) immediately following the hacks; and 2) Some tokens are able to recover over time. An additional point worth noting here is that none of these protocols had native token backed insurance funds (as the SM); as such, the price impact of a shortfall event on AAVE could be greater.


Figure 2. Soure: Data from Coingecko. Calculations my own.

Considering the above, a useful liquidation mechanism could be put in place whereas, given a shortfall event, the SM liquidation would happen gradually over a predetermined period of time. This would mitigate the reflexive dynamic pointed in Figure 1 and would also potentially allow AAVE price to recover before starting to liquidate the assets.

As was pointed before, the higher the share of AAVE within the SM, the more powerful the reflexive dynamic in Figure 1 becomes. In this sense, another mechanism that could help mitigate that dynamic is adding other assets to the SM (this is where the BPT introduction comes into play). The best assets suited for this purpose would be assets with low correlation to AAVE and low volatility. Low correlation with AAVE is needed because, as correlation rises, real diversification from adding a new asset declines. In other words, adding highly correlated assets to the SM would virtually just mean keeping it 100% in AAVE. On the other hand, low volatility is needed so that the value of the SM doesn’t aggressively change over time. Let’s explore how ETH, which is the second asset proposed to be part of the SM, behaves for these two metrics.

First, let’s consider ETH and AAVE correlation. The correlation coefficient between these two assets stands at 0.56, which implies low to moderate correlation. The following graph shows a plot of the logarithmic return correlation between these two assets.


Figure 3. Data from Coingecko. Calculations my own.

As was mentioned before, a good asset to be added to the SM should have low volatility. The following graph shows the 30-day volatility of ETH (red) versus AAVE (green). What’s clear from that graph is that ETH has experienced consistently lower volatility than AAVE for most of the examined period.


Figure 4. 30-Day Volatility. ETH (red) and AAVE (green). Source: Coinmetrics.

Putting the above together, ETH is an asset that presents low-to-moderate correlation to AAVE and consistently lower volatility. Thus, I consider its addition to the SM a positive step towards making the SM more robust (and less reflexive). And I say a step because even with this addition the SM will still be highly exposed to the price of AAVE. The next table shows how the AAVE and ETH shares of the SM evolve as the share of the BPT in the SM increases. As can be seen, even at 100% BPT share of the SM, it’s still 80% AAVE overall.


Table 1. AAVE and ETH Share of SM vs. BPT Share of SM.

The 80/20 AAVE/ETH BPT design decision, however, was made taking other additional factors into consideration. One of those factors is protecting stakers from impermanent loss and allowing them to still be highly exposed to AAVE – that’s in part why the 80/20 decision was made. As the share of ETH in the BPT increases, stakers would be less exposed to AAVE and more exposed to impermanent loss.

If DeFi has taught me anything, it’s that every design decision comes with tradeoffs. In this case, the tradeoff of the 80/20 Balancer Pool is between diversification (as the share of ETH increases, diversification of the SM increases) and staker incentives (as the share of ETH increases, stakers are less exposed to AAVE and more exposed to impermanent loss). In this sense, I think the 80/20 design decision strikes a good balance between SM diversification and staker incentives.

Let me conclude by saying that this ARC (if passed) marks the beginning of the journey for Aave’s Safety Module. On one hand, it introduces slashing, which underpins the main functionality the SM serves. On the other hand, it introduces a BPT 80/20 AAVE/ETH as a new asset backing the SM – making it more robust and better suited to serve its purpose. As I’ve argued in this piece, I welcome these developments for the SM and look forward to the next evolutions of this critical piece of infrastructure within the Aave ecosystem.

7 Likes

Looking forward to that update, @Dydymoon!

Just wanted to ask, what’s the motivation behind increasing the emission rate to 2000 AAVE/day?

Hey @JonathanErlich! Thanks for the interesting and in-depth analysis, however, I’d like to add my feedback!

I actually fundamentally disagree with the premise of this statement. Should the safety module slashing event occur, I believe trust in the platform would rise. This implies that the in-built insurance system works! With that said, should the Aave platform itself have a smart contract failure, this is much more akin to your example.

It’s likely, though, that there would be selling from external AAVE holders in anticipation of the slashing sell-off. However, I believe that after the slashing event occurs, stability (or, at least, crypto stability) will quickly claw its way back to the market. Slashing is a risk stakers, and to a lesser extent holders, knowingly take.

I believe the most likely scenario would be the failure of a given ERC20 asset, resulting in a lack of profitable liquidation opportunities for loans taken with this reserve as collateral. If slashing successfully covers the necessary loan amount, then this would undoubtedly greatly bolster trust in the Aave protocol, which would be healthy for the protocol.

Your vicious cycle is definitely interesting and worth thinking about. Perhaps this can be mitigated by gradual slashing as you mentioned, however, I personally need to put more thought into this. Complex stuff!

On your last point, adding other assets to the safety module should definitely be considered. BPTs are a great start. I might not be 100% opposed to allowing ETH as a security module asset in the future, either, but I need to give it more thought. This issue stems from the predicament we’re in where the most hardcore believers in the protocol, i.e: stakers, are the ones most at risk of losing their governance power.

On the other hand, there is a deeply beneficial alignment of incentives that occurs with stakers having to put said governance power on the line. Since their assets, and governance power, are at stake (pun DeFinitely intended), it’s a top priority for stakers to maintain appropriate risk parameters.

Lastly, it’s also important to keep in mind that, in the future, risk tranching might be a great alternative to manage staking risk. How this is done is up for debate, but I’m pretty excited to see what we as a community can come up with.

In closing, I want to ensure that the focus of the Aave protocol remains on long-term sustainability, security and growth. Short-term token prices willl react to short term events, but long-term prices will react to the quality of the protocol.

Love seeing more and more great input!

2 Likes

A lot of great ideas here. I’ll chime in here with one: dynamic reward distribution.

TL;DR: CDS markets popping up (aka COVER) create a better proxy for the level of risk in protocols and that should be the benchmark for rewarding stakers on an ongoing basis (not static).

It feels somewhat suboptimal/arbitrary to split rewards 50-50 between stakers and LPs. Both are equally important but no amount of incentives will attract LPs if there is not sufficient security (or perception of it, at least). Rather than reward in equal parts, perhaps we can introduce a dynamic reward distribution system that ensures stakers get a minimum viable yield for backstopping the protocol in the event of losses. This prevailing yield on AAVE Claim Tokens on Cover + [potentially some premium] could be a good proxy for the implied level of risk taken by stakers.

In this dynamic rebalancing mechanism, the # of rewards (with a certain min and/or max) diverted to stakers are in flux to ensure they are being properly compensated for the level of risk they are taking on at any given point in time (vs. static under the current design). Any excess rewards are then distributed to LPs. The min-max range gives LPs some level of certainty on the expected yield.

Perhaps the main drawback of this dynamic reward mechanisms is that it introduces more uncertainty to LPs, which in an extreme scenario may get very little yield. That said, LPs don’t get any rewards today so I see this as being less controversial than not properly incentivizing stakers to secure the protocol. Said differently, an LP would be ok not getting a reward so long as the network is secure.

In theory, my hypothesis is that this design is more efficient than the current static distribution one, but I’m less sure of how to actually implement it (and if it’s practically possible without introducing too much complexity).

Open to ideas and thoughts.

1 Like

Hey Santiago,

Totally agree that an arbitrary reward split is suboptimal and that fees should instead be based on supply/demand dynamics. I like your idea about using COVER price as an oracle, but I think there are quite a few execution problems with this, not least of which that COVER is an unlevered system which, at least currently, results in high prices. We believe an interesting solution to this (which will also be incorporated into our next proposal) is breaking out insurance as a separate product on the demand side (i.e. offer insured and uninsured APYs to depositors) such that it’s possible to compute insurance demand / capacity separately from money market demand. This also opens up the possibility of making Aave’s insurance fund a distinct product in and of itself, insuring other protocols and projects.

1 Like

I like this quite a lot.

Hi all,
I’ve been thinking about the 50/50 split between StkAAAVE and BPT. In short I for one find it difficult to justify it.

Lets say that StkAAVE vs BPT staking proportions end up being 80/20 then it creates an unfair reward distribution for StkAAVE stakers, as they absorb most of the SM risk and only 50% of daily AAVE distribution. An inverse scenario would mean the same for BPT stakers.

Clearly these risks profiles are not the same in the full picture, however I do believe that when it comes to safeguarding the SM every staked token should benefit from rewards pro-rata. Thus, both BPT and StkAAVE participants should have access to one pool of rewards and receive them proportionally to the value of their stake.

Another noteworthy fact is that Balancer smart contract BPT risk is being fairly covered by the Balancer distribution as well as the trading fees.

I also agree with raising the total rewards to 1100 AAVE/day as the SM needs more staked volume, but not with the 50/50 split. Also the idea of having tranches of risks in the future is very interesting. For example there may be pools for those who are prepared to lose even 100% of their stake in an emergency for higher rewards of course. In that scenario the split would make sense. In the current one, it is unnecessary and potentially detrimental to either StkAAVE or BPT as we cannot ascertain whether their respective shares will end up being 50/50 of the total staked volume, nor is it imperative that they end up hovering along those lines long-term.

4 Likes

Yes, I thought this myself. It could also occur that people staking Aave are not happy to take the possible 30% slashing risk for a 5-6% return per annum. Especially as there may be other platforms offering more lucrative returns with lower risk. Could the 1100 be split between both pool, with a bigger weighting to whoever is providing the most liquidity to the safety module?

4 Likes

Thank you for all the points you made. From what I understand about this project and your proposals, It makes sense to have that 80:20 mix. Would a Stable coin added to that mix maybe as 10% be a good option as well? Offering a better buffer to volatility? So maybe 70% Aave: 20% ETH: 10% HUSD?
All thoughts are welcome here. I am not a Financial Adviser but have been in Crypto since 2017 and understand the volatility and I am trying to understand how to mitigate this. Anyway that’s my two Sats. Thank you:)

3 Likes

I like the idea of an 80/20 pool, but there’s more numbers to pick besides the ratio. There is also the swap fee.

It looks like someone already made a 80/20 pool with a 0.9% swap fee: https://pools.balancer.exchange/#/pool/0x6c18f4269c1f97531a04c7d87b949f9a7f4abe33/

The 50/50 pool on balancer has a 0.15% swap fee. https://pools.balancer.exchange/#/pool/0x7c90a3cd7ec80dd2f633ed562480abbeed3be546/

Uniswap charges a 0.3% fee.

I also like the idea of including a stablecoin, but I wouldn’t want to use a custodial one (like husd) and am not sure what decentralized one would be better.

1 Like

Can we have an AIP for the stakers compensation increase from 400 to 1100 AAVE/day? I for one would vote on the increase for the entire pool of staked assets for start - AAVE and BPT coming from the balancer AAVE/ETH. I believe any splits or staking architecture modification need more discussion especially when the Delphi Digital proposal is out. Let’s keep the staking simple enough for the time being until those details are ironed out and their feasibility is closely examined.

2 Likes

I’m new here and I am very interested in the BPT part. Is there any AIP after this?

Hey, we have no date for the Balancer pool AAVE/ETH yet but as BAL has been listed as a collateral, the AIP should come soon imo :slight_smile: