[ARFC] Add MKR to Ethereum v3

[Llamaxyz]

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Title: [ARFC] Add MKR to Ethereum v3
Author: @Llamaxyz - DeFi_Consulting (@matthewgraham), ACI (@MarcZeller) and 3SE
Dated: 2023-02-18

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Summary

This proposal presents Aave the opportunity to onboard MKR to the Ethereum v3 Liquidity Pool.

Abstract

MKR is the governance token of the Maker DAO ecosystem. MKR token holders govern the Maker Protocol, the smart contracts that power DAI. There is currently $12.71m of MKR deposited into Aave v2 on Ethereum. This proposal grants Aave the opportunity to list the governance token of the community supporting DAI which contributes $167m of TVL on the Ethereum v2 deployment.

This ARFC is a joint effort with ACI and 3SE to allow a selection of v2 listed assets to be onboarded on V3 via the governance process. Subject to a favourable Snapshot vote, Llama will submit an AIP for voting.

Motivation

Maker DAO has over $7.45B in TVL and is ranked second on Defi Llama TVL rankings. The Maker Protocol is only deployed on the Ethereum network. The stable coin DAI, provides $167m of deposits into Aave v2 on Ethereum, with over $103m of this supply being borrowed by users.

The risk parameters provided here within are from Gauntlet’s original Aave v3 initial assets listings and configurations forum thread. These parameters are to be revised by Gauntlet and feedback will be incorporated before progressing to a Snapshot vote.

The interest rate provided in the proposal mirrors the v2 deployment with exception of the parameters specific to stable interest rates. The stable rates proposed are the somewhat generic listing rates as stable borrowing is disabled. However, if stable borrowing was enabled, the suggested parameters are suitable and don’t create any undesirable dynamics between stable and variable rates.

We note that this proposal is to be reviewed by Gauntlet, with feedback incorporated, prior to progressing to Snapshot.

Specification

Ticker: MKR

Contract Address: 0xba100000625a3754423978a60c9317c58a424e3D

Risk Parameter	Value
Isolation Mode	YES
Enable Borrow	YES
Enable Collateral	YES
Loan To Value	65.00%
Liquidation Threshold	70.00%
Liquidation Bonus	8.50%
Reserve Factor	20.00%
Liquidation Protocol Fee	10.00%
Borrow Cap	1,500
Supply Cap	6,000
Debt Ceiling	$2,500,000
Variable Base	0.00%
Variable Slope1	7.00%
Variable Slope2	300.00%
Uoptimal	45%
Stable Borrowing	Disabled
Stable Slope1	13.00%
Stable Slope2	300.00%
Base Stable Rate Offset	3.00%
Stable Rate Excess Offset	5.00%
Optimal Stable To Total Debt Ratio	20.00%

Note: Stable borrowing is disabled, however parameters are provided in case stable borrowing is enabled at a later date without amending any parameters.

Copyright

Copyright and related rights waived via CC0.

[MarcZeller]

Hello, and thank you, @Llamaxyz, for submitting these proposals in the forum.

Since the proposals are presented in separate threads to allow governance granularity, the ACI’s response will be variations of this current post on each thread.

The main use case for MKR on Aave is to allow MKR holders to use their assets to borrow. However, historically there has been little to no borrowing volume of these assets, so the ACI recommends a “NO” to enable borrowing.

This is in line with previous concerns raised by @monet-supply on the forum last year. The ACI is supportive of allowing MKR as a collateral asset in “isolation mode” only. This means that MKR can be used as collateral but cannot be borrowed.

The ACI believes it’s better to leave GHO out of isolation mode in the early days and not allow some assets to be collateral to mint it.

Since MKR is a governance asset, an upcoming upgrade by @bgdlabs might allow aMKR holders to keep their governance rights in Maker. The ACI believes this is a nice synergistic opportunity for MKR holders.

To summarize, the ACI is supportive of this proposal if the asset is not allowed to be borrowed and if Gho is not part of isolation mode.

[ChaosLabs]

We support the listing of MKR in isolation mode. Additionally, as part of our effort to de-risk V2 assets, we have proposed to decrease the LT and LTV for MKR on Ethereum V2. Full details of this proposal can be found here

Chaos Labs is looking into the initial parameters listed on this post and will collaborate with Gauntlet to provide updated parameter recommendations per our joint New Asset Listings Framework.

[ChaosLabs]

MKR Parameter Recommendations:

Gauntlet and Chaos Labs have collaborated and shared our independent analyses for the listing of MKR on V3 Ethereum.

The main differences between the analyses were the supply cap, borrow cap, debt ceiling, and Liquidation Bonus recommendations. Chaos Labs recommended a lower supply cap and debt ceiling, while Gauntlet recommended a lower borrow cap. The joint recommendation was to adopt the lower figures as they are high enough to enable growth and migration from V2 and can be increased at a later stage. Additionally, Gauntlet recommended a slightly higher liquidation bonus which was adopted for the launch.

Below you can find a joint recommendation with the initial parameters followed by the analysis of each party.

Risk Parameter	Value
Isolation Mode	YES
Enable Borrow	YES
Enable Collateral	YES
Loan To Value	65.00%
Liquidation Threshold	70.00%
Liquidation Bonus	8.5%
Reserve Factor	20.00%
Liquidation Protocol Fee	10.00%
Borrow Cap	1,500
Supply Cap	6,000
Debt Ceiling	$2,500,000
Variable Base	0.00%
Variable Slope1	7.00%
Variable Slope2	300.00%
Uoptimal	45%
Stable Borrowing	Disabled
Stable Slope1	13.00%
Stable Slope2	300.00%
Base Stable Rate Offset	3.00%
Stable Rate Excess Offset	5.00%
Optimal Stable To Total Debt Ratio	20.00%

Gauntlet Analysis

Gauntlet recommends making the following changes to the initial Aave V3 ETH recs for MKR:

Syntax	Description
Liquidation Bonus	8.5%
Supply Cap	10k
Stable Slope1	13.00%

Given that MKR will be in isolation mode and have a debt ceiling, Gauntlet supports the LTV and liquidation threshold increase. However, our analysis shows that a liquidation bonus decrease from the proposed parameters would still properly incentivize liquidators. According to our borrow and supply cap methodology, the proposed would be too high. A 25k supply cap would be reasonable, however, a 10k initial supply cap should provide room for growth and mitigate outsized risk. Of course, debt ceiling changes will also need to consider supply cap changes. The stable slope1 increase keeps the stable and variable interest rate models proportional to the ones suggested here.

Chaos Labs Analysis

Overview

Chaos Labs supports listing MKR in Isolation Mode as part of an overarching strategy to increase the offering of AAVE protocol with more volatile assets. As a low market cap asset, MKR is susceptible to price manipulation, so listing it with an appropriate debt ceiling is crucial to prevent a profitable pump attack.

Liquidity and Market Cap

When analyzing market cap and trading volumes of assets for listing, we are looking at the past 180 days, especially in light of the recent market turbulence. The average market cap of MKR over the past 180 days was $649M, and the average daily trading volume was $29M (CeFi & DeFi). We find the market cap reasonable for listing. While the low trading volumes signal low liquidity in the markets, they can be addressed by the supply caps, debt ceiling, and borrow caps.

Liquidation Threshold

Analyzing MKR price volatility over the past year, we observed daily annualized volatility of 84% and 30-day annualized volatility of 99%. Considering this volatility, we support the suggested LT of 70%.

We support listing MKR as borrowable under reasonable limits of supply cap, as we do not observe a significant risk to the protocol by allowing to borrow MKR, as long as it is bound by a well-defined cap.

Debt Ceiling

Following Chaos Labs’ Isolation Mode Methodology, which we will publish shortly, we recommend an initial debt ceiling of $2.5M. Under the methodology for Isolation Mode, we consider two levels of probabilities for extreme price drops - Medium-High and High. We estimate the MKR probability for an extreme price drop as Medium-High. Given this debt ceiling, we do not identify a profitable attack vector under the current liquidity levels.

Supply Cap, Borrow Cap, and Liquidation Bonus

Following Chaos Labs’ approach to initial supply caps, as introduced with the Metis deployment recommendations, we propose setting the Supply Cap at 2X the liquidity available under the Liquidation Penalty price impact.

We recommend a 7.5% Liquidation Bonus and a derived supply cap of 6,000 MKR, and a borrow cap of 3,300 MKR.

Recommendations

We support the recommendations in the post for the Reserve Factor, Liquidation Protocol Fee, and Interest Rate curves.

Following the above analysis, we recommend listing BAL with the following parameter settings:

Isolation Mode	Enable Borrow	Enable Collateral	LTV	LT	Liquidation Bonus	Reserve Factor	LPF	Supply Cap	Borrow Cap	Debt Ceiling
Yes	Yes	Yes	65%	70%	7.5%	20%	0.1	6,000	3,300	$2.5M

[sakulstra]

@ChaosLabs

The joint recommendation was to adopt the lower figures as they are high enough to enable growth and migration from V2 and can be increased at a later stage.

I’ve a question on that (same question applies for uni, snx, crv). Looking at the top 10 holders of these v2 assets a lot of them have mixed positions (e.g. mkr+uni collateral). Therefore when one of these assets is put in isolation a migration relying on mixed collateral will not actually be possible.

Non of these assets are currently frozen on v2 and can potentially be used as collateral with no restriction as I understand the pool configuration. How can it be that on v3 these assets - volatile, but with a long track record are now deemed isolated, when at the same time there are no concerns on v2? Afaik they are borrowing disabled, so I would have assumed the same on v3 or a restrictive borrow cap, but isolation makes a migration to v3 impossible/unattractive.

[ChaosLabs]

V2 → V3 Migration

Any asset listed on AAVE V3 that is also listed on AAVE V2 must be competitive in lending and borrowing terms. Otherwise, users will keep using AAVE V2. As you have accurately noted, listing the assets mentioned above in Isolation Mode is more restrictive than the cross-collateral functionality still available on AAVE V2.

The migration of such assets will be an iterative process:

1. Listing the asset on AAVE V3
2. Reducing the lending and borrowing terms on AAVE V2. We have a few tools to promote this: interest rate changes, disabling borrows, disabling use as collateral, and freezing assets altogether.
3. Monitoring the transition and (if needed) taking steps to increase the attractiveness of lending and/or borrowing on V3 while decreasing on V2.

We are awaiting the community vote on the four assets, but once it passes, we intend to follow up with a proposal to freeze the supply for those assets on V2.

It is important to note that we still need to make the AAVE V3 markets more appealing to MKR, UNI, and SNX holders over time. Analyzing the collateral compositions of the top 10 suppliers of these tokens in AAVE V2, we see that these positions have massive stETH supply that outnumbers their supply of the newly listed tokens. This means that to promote the migration of liquidity to V3, we need not only to attend to the direct parameters of these three tokens but also to look at the full picture. According to the collateral analysis of the top 10 suppliers of those assets, it is highly likely that even if all were listed with higher LT and outside of isolation mode, we would see little migration as most of their collateral is wstETH, for which current parameters on V3 are significantly inferior to V2 outside of E-Mode.

We have started working on a Migration Methodology to facilitate the transition of funds from AAVE V2 to AAVE V3. However, as seen in this instance, it requires an overarching strategy to accommodate all token holders’ needs. We are currently moving forward with specific listings and parameter settings that we identify as safe. These are generally over-conservative and lack the incentivization required to facilitate the full migration from V2 to V3, for which we will lay down a more robust approach in the coming weeks.

GHO Launch

An additional consideration for launching volatile assets in isolation mode on V3 Ethereum is a safeguarded launch for GHO, as stated in our original proposal for asset configurations for the V3 Ethereum launch

@ChaosLabs

Our recommendation is to have a 2-phased approach regarding the assets initially listed. It’s important to emphasize - per our understanding with core contributors - GHO is just a normal V3 asset. It doesn’t benefit from any extra feature, such as only being mintable by some assets or debt ceilings. The only way to restrict collaterals would be with isolation mode. Therefore, the limited assets in our proposal are by design. We want to support a safeguarded GHO launch, ensure high-quality collateral for GHO minting, and allow more time for a community discussion regarding the long-tail assets to be listed, given considerations (GHO launch, economic viability ) that were not taken into account in the original Snapshot.

[Llamaxyz]

Hi Everyone,

Llama has created a Snapshot that incorporates the MKR parameters as suggested by Chaos Labs and Gauntlet.

https://snapshot.org/#/aave.eth/proposal/0xf4aec3fbab5096752be96f0e5b522f37318c1902cf8b897b049b7a94d478de73

Thank you to everyone for contributing to the discussion, especially Chaos and Gauntlet for supporting on the risk parameters.