[ARFC] Aave V2 Deprecation Update - Disable New Borrows, IR Curve and Reserve Factor Adjustments

Overview

In this recommendation, we propose steps to continue deprecating the Aave V2 instances. As such, we recommend implementing the changes proposed in our previous recommendation on Aave v2 Ethereum, disabling borrows across all assets, raising the reserve factor in all frozen markets, and reducing interest rates in markets where bad debt constitutes a significant portion of the total outstanding debt.

Motivation

The rationale behind the previously proposed changes remains valid, ensuring a controlled and secure transition away from Aave V2.

In addition, we propose further changes aimed at standardizing the parameters in the market, improving the deprecation speed of frozen markets, and reducing the risks posed by volatile collateral assets.

In order to reduce risk we recommend disabling borrows across all assets, preventing further growth of risky debt positions. This measure ensures that positions utilizing volatile or risky collateral cannot increase their leverage within the legacy implementation. It also reduces the risk of price manipulation via oracle dependencies within the V2 instance.

We also recommend standardizing the interest rate parameters of all the frozen assets by setting a minimum base rate of 20% and a Slope 2 of 300%. This step will ensure that existing positions will be strongly incentivized to repay in order to avoid fast debt accrual that can lead to liquidations. As some of the borrow utilization of the assets in question comes from bad debt accrued over the lifespan of Aave V2, we recommend setting the reserve factor of all the frozen assets to 99%. This measure prevents Aave DAO from accruing additional net bad debt for the reasons covered in the following section.

Bad Debt

The total bad debt currently owed by Aave DAO on Aave V2 stands at approximately $954,000. This debt is primarily concentrated in stablecoins, accounting for around 88.5% of the total, with AMPL and BUSD comprising the majority.

While this value represents the nominal debt owed by the Aave DAO, thanks to the introduction of a high Reserve Factor on many of the markets, a significant portion of the accrued interest on the bad debt also represents an equal value of DAO revenue, effectively mitigating the future cost of repayment. This offsets the bad debt accrued interest, which is collected at the time of repayment of the debt itself, as the accrued Reserve Factor gets claimed in the form of aTokens once the debt is closed.

For this reason, the growth of the bad debt through interest accrual still poses minimal problems, as while the net value of the debt grows significantly slower than the debt itself, the DAO will still require the use of a bigger capital in order to start the repayment process. While interest rate adjustments have been made in the past to mitigate this issue, we recommend minimizing the interest rate curve of assets where over 90% of the borrowed value is bad debt. The current annual virtual bad debt accrual remains at 24% APR, which represents minimal issues to the Aave DAO.

For additional context, the value of the bad debt on the 1st of August 2024 was $706,000, and we can safely assume that the majority of the growth in value since then has been only virtual.

Roughly 98% of the total accrued bad debt is currently outstanding on the Ethereum instance with only 3,400$ of bad debt being accrued between the Avalanche and Polygon instances.

The positions that constitute the largest bad debt holders are depicted in the chart below. Notably, the top ten debtors predominantly hold AMPL or BUSD debt.

The markets with the highest percentage of borrows represented by bad debt are BUSD, MANA, and TUSD. Other markets, including AMPL, GUSD, sUSD, and renFIL, also exhibit substantial bad debt but to a lesser extent.

Given this distribution of positions and bad debt, we recommend reducing the interest rate for the markets where the Bad Debt represents the majority of the borrows to 1% (>90%), while for the markets where a significant part is still represented by user’s demand with a 20% base and a 300% Slope 2.

Specification

Ethereum V2

Implement previously proposed modifications to Aave V2 as per here.

Asset Chain Current RF Recommended RF Current Slope2 Recommended Slope2
USDC Ethereum 85% 70% 60% 60%
USDT Ethereum 85% 70% 100% 60%
DAI Ethereum 85% 70% 75% 60%

Disable new borrows across all assets in Aave V2 to prevent further debt accumulation.

Asset Chain Borrowable Current Value Borrowable Recommended
WAVAX Avalanche Yes No
DAI.e Avalanche Yes No
USDT.e Avalanche Yes No
WETH.e Avalanche Yes No
WBTC.e Avalanche Yes No
ENJ Ethereum Yes No
USDT Ethereum Yes No
KNC Ethereum Yes No
renFIL Ethereum Yes No
DAI Ethereum Yes No
WBTC Ethereum Yes No
UST Ethereum Yes No
BUSD Ethereum Yes No
USDC Ethereum Yes No
MANA Ethereum Yes No
YFI Ethereum Yes No
RAI Ethereum Yes No
AMPL Ethereum Yes No
WETH Ethereum Yes No
FEI Ethereum Yes No
CRV Polygon Yes No
LINK Polygon Yes No
BAL Polygon Yes No
USDT Polygon Yes No
WETH Polygon Yes No
USDC.e Polygon Yes No
WBTC Polygon Yes No
WPOL Polygon Yes No
DAI Polygon Yes No

Adjust interest rate parameters in markets where bad debt constitutes a significant portion of the total outstanding debt, ensuring that accrual rates do not exacerbate financial losses.

Asset Chain Current Base Current Slope 1 Current Slope 2 Current UOptimal Current Reserve Factor Recommended Base Recommended Slope 1 Recommended Slope 2 Recommended UOptimal Recommended Reserve Factor
BUSD Ethereum 10% 0% 0% 1% 99.99% 1% 0% 0% 1% -
ZRX Ethereum 20% 0% 300% 45% 99.99% 1% 0% 0% 1% -
BAT Ethereum 20% 0% 300% 45% 99.99% 1% 0% 0% 1% -
MANA Ethereum 20% 0% 300% 45% 99.99% 1% 0% 0% 1% -
FEI Ethereum 0% 4% 100% 1% 99.99% 20% 0% 300% 45% -
sUSD Ethereum 3% 15% 200% 20% 99.99% 20% 0% 300% 45% -
LUSD Ethereum 3% 15% 200% 20% 99.99% 20% 0% 300% 45% -
USDP Ethereum 3% 15% 200% 20% 99.99% 20% 0% 300% 45% -
FRAX Ethereum 3% 15% 200% 20% 99.99% 20% 0% 300% 45% -
GUSD Ethereum 3% 15% 200% 20% 99.99% 20% 0% 300% 45% -
TUSD Ethereum 10% 0% 0% 1% 99.99% 20% - 300% 45% -
renFIL Ethereum 0% 0% 0% 0% 35.00% 20% - 300% 45% 99.99%
LINK Ethereum 0% 7% 300% 45% 90.00% 20% 0% - - 99.99%
UST Ethereum 20% 0% 300% 80% 99.99% - 0% - 45% -
RAI Ethereum 20% 0% 300% 80% 99.99% - - - 45% -
KNC Ethereum 20% 0% 300% 65% 99.99% - - - 45% -
AMPL Ethereum 20% 0% 300% 80% 99.99% - - - 45% -
BAL Ethereum 20% 0% 300% 80% 99.99% - - - 45% -
DPI Ethereum 20% 0% 300% 50% 99.99% - - - 45% -
SNX Ethereum 20% 0% 300% 80% 99.99% - - - 45% -
UNI Ethereum 20% 0% 300% 45% 99.99% - 0% - - -
CRV Ethereum 20% 0% 300% 45% 99.99% - 0% - - -
YFI Ethereum 20% 0% 300% 45% 99.99% - 0% - - -
BAL Polygon 5% 50% 134% 20% 99.99% 20% 0% 300% 45% -
GHST Polygon 0% 50% 134% 10% 99.99% 20% 0% 300% 45% -
CRV Polygon 3% 50% 134% 10% 99.99% 20% 0% 300% 45% -
LINK Polygon 0% 50% 134% 10% 99.99% 20% 0% 300% 45% -
WBTC.e Avalanche 0% 7% 300% 45% 85.00% 20% 0% - - 99.99%

Disclaimer

Chaos Labs has not been compensated by any third party for publishing this ARFC.

Copyright

Copyright and related rights waived via CC0

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LlamaRisk supports these changes.

We’ve already expressed our favorable view regarding the adjustments to the reserve factor and Slope2 settings on the Aave V2 Ethereum stables (USDC/USDT/DAI). In our view, moving forward by disabling new borrows on all assets is the next logical step to accelerate the deprecation of V2. The proposed minimum base rate of 20% coupled with a Slope2 of 300% creates strong incentives for borrowers to repay.

Setting the reserve factor to 99% ensures that nearly all accrued interest flows to the protocol. This measure minimizes the risk of nominal increase in value of bad debt.

We would like to note that as the complete shutdown of V2 draws near—and with the transition of the Aave Safety Module over to the Umbrella system—it would be opportune to consider using treasury funds to cover any remaining bad debt.

1 Like