[ARC]: Risk Parameter Updates for Aave V3 Optimism 2022-12-29

After reviewing the post, we wanted to share our reservations about the proposed recommendation and share our analysis before Gauntlet moves forward with an AIP.
Moving forward, we’d appreciate if Gauntlet could share their analysis before posting to avoid community confusion, as already discussed on several threads.

After looking into the state of AAVE token supply on Optimism, we have identified that the current supply of AAVE tokens on the v3 Optimism market (~88K) significantly exceeds the available liquidity on Optimism.
The high exposure is mainly due to a single position that accounts for 87% of the supply (~79K of ~88K)

Following our Supply Cap Methodology, we recommend setting the AAVE token on Optimism at 14K, based on the current liquidity levels on Optimism (detailed analysis below)

We are aware that setting a supply cap below the current supply is not the best practice. However, the current state is a market distortion that was caused as a result of there being no cap for AAVE on Optimism. Practically, if this single position highlighted above were to be closed, the recommended supply cap would be around 40% above the current supply, which is very reasonable from a usability perspective.

Analysis of AAVE token supply on Optimism

When observing the accounts that supply AAVE tokens to AAVE V3 on Optimism we have identified a single account supplied 79k AAVE position, 87% of total supply, at current health of ~1.6.

The approach to setting the supply cap for AAVE tokens on Optimism

This amount cannot be liquidated with the current AAVE liquidity on Optimism. While this account is an active, healthy account, it is still a risk for the protocol that should have been avoided had supply caps been in place. Therefore, the approach we took was to set the supply cap using the methodology according to the distribution of the other accounts, excluding the account with the biggest position. The reasoning behind this is that while this position is open, there is risk exposure that we cannot mitigate without forcing liquidation of the position. Therefore, the best approach would be to set appropriate risk parameters that will secure the protocol if this position is closed.

The recommended Supply Cap

Based on the approach described above, our simulations have produced r=0.278, which yields: (currentSupply - supply of 0x36..a8a)/r*marketCapFactor = 10k / 0.278 * 0.39 = 14K.

Our recommendation is to set the Supply Cap for AAVE tokens on Optimism at 14K.

While this cap effectively pauses AAVE supply, until the position opened by 0x36c4bd54d54dd898c242f5f634f5d0cef3be2a8a is closed, we believe it is the appropriate cap that will secure AAVE V3 on Optimism.

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