[ARFC] Increase wstETH Borrow Rate on Lido Instance

[ACI]

[ARFC] [ARFC] Increase wstETH Borrow Rate on Lido Instance

Author: ACI

Date: 2024-11-06

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ARFC has been updated with latest Risk Parameters provided by Risk Service Providers 2024-11-12

Summary

This ARFC proposes to increase the wstETH borrow rate on the Lido instance of Aave to better reflect the current demand for wstETH borrows and to transition towards a sustainable yield model for wstETH depositors.

Motivation

The introduction of liquid E-Modes and the onboarding of LRT collateral with wstETH debt have been highly successful, as evidenced by Renzo’s ezETH reaching supply caps and growing to over $150m TVL shortly after launch. This success has created a significant demand for wstETH borrows, making LRT looping an attractive use case for Aave users.

Since the launch of the Lido instance, Aave DAO and Lido have subsidized wstETH deposits with additional incentives. However, with liquid E-Modes in place, high borrow demand from LRTs, and the successful bootstrapping of real yield to wstETH depositors, it’s now appropriate to start replacing these incentives with real yield generated from wstETH borrowing activity.

To achieve this transition, we propose increasing the base wstETH borrow rate to 1% and adjusting slope1 to match the ETH staking yield at 3%. This adjustment aims to maintain profitability for wstETH borrowers while enhancing the native supply yield for wstETH depositors, creating a more sustainable and market-driven yield structure.

Specification

Risk Parameters has been updated by adding latest Risk Service Providers feedback 2024-11-12

Parameter	Current Value	Recommended Value
Base	0.00%	1.00%
Slope 1	2.25%	2.25%
Slope 2	85.00%	85.00%
UOptimal	80.00%	80.00%

Useful links

[ARFC] Chaos Labs Risk Parameter Updates - wstETH liquid e-modes on Arbitrum, Base, Scroll - 11.01.24

Summary With the release of Aave v3.2 and the introduction of Liquid E-Modes, we now have the capability to assign multiple E-Modes to a single asset. This proposal introduces a wstETH/WETH E-Mode on the Arbitrum, Base, and Scroll chains. Motivation Prior to Aave v3.2, E-Mode configurations were constrained to the least liquid and stable asset within each E-Mode pool, limiting capital efficiency. Liquid E-Modes now enable more tailored E-Mode configurations, allowing for optimization across dif…

[ARFC] Chaos Labs Risk Parameter Updates - wstETH / WETH E-mode Parameters for Lido Market - 10/20/24

Summary With the introduction of Aave v3.2 and Liquid E-Modes, it is now possible to assign multiple E-Modes to a single asset. In this recommendation, we evaluate the E-Mode parameters for the wstETH/WETH category in the Ethereum Lido market and propose changes following Chaos Labs’ methodologies. Motivation While factoring in on-chain liquidity, historical volatility, and daily price movements supports the current LTV, LT, and Liquidation Bonus settings for wstETH and WETH in the Lido market,…

Disclaimer

This proposal is directly powered by ACI. ACI did not received compensation for the creation of this proposal.

Next Steps

1. If consensus is reached on this ARFC, escalate this proposal to the Snapshot stage.
2. If the ARFC snapshot outcome is YAE, publish an AIP vote for final confirmation and enforcement of the proposal

Copyright

Copyright and related rights waived via CC0.

[LlamaRisk]

Summary

LlamaRisk supports the recommended increase in the wstETH borrow rate on the Lido instance. The introduction of ezETH as collateral and the ezETH/wstETH E-mode has attracted significant borrowing demand for wstETH. The wstETH borrow utilization, at 76% of capacity, is now enough to sustain a wstETH lending rate that is equal to what the awstETH lending incentive provided (0.17% APY). It makes sense to sunset this incentive and to raise the wstETH borrow rate.

We analyze a scenario where the utilization remains the same after implementing the proposed changes. We found that the borrowing rate would increase to a maximum of 1.63%. Note that calculating the same scenario by fixing the borrowing rate instead is not applicable, as the current borrow rate (0.71%) is lower than the proposed base rate of 1.00%.

	Borrow rate	Utilization
Current	0.71%	25.14%
Max utilization sensitivity	+1.63%	25.14%

Source: LlamaRisk, November 7th, 2024

With a borrowing rate of 1.63% and ezETH yield of 6.31%, leveraged ezETH/wstETH will be slightly less profitable but still very competitive with a double-digit APY yield. For instance, the ezETH yield layer on Cian Protocol currently yields 14.27% through leveraged ezETH/wstETH on Aave. We expect little churn from this move, as it will remain one of the most profitable risk-adjusted strategies on the market due to the automated farming of EIGEN rewards offered by Renzo.

Click to reveal our methodology

Details on methodology

We model the Slope1 component of the Interest Rate Model (IRM) as an affine function y = ax + b, where:

• y represents the borrowing rate
• a represents the Slope1 rate
• x represents the utilization rate
• b represents the base borrow rate

Given points A = (0; b) and B = (uOptimal; Slope1 rate), we calculate a using a = (y_B - y_A)/(x_B - x_A). We can then analyze two extreme scenarios: solving for utilization rate x using current borrowing rate y (maximum borrowing sensitivity) and solving for borrowing rate y using current utilization rate x (maximum utilization sensitivity).

These projections assume rational market behavior under perfect conditions, with all other variables remaining constant. The model is valid only when utilization remains below uOptimal, above which the Slope2 component requires separate modeling.

Disclaimer

This review was independently prepared by LlamaRisk, a community-led non-profit decentralized organization funded in part by the Aave DAO. LlamaRisk is not directly affiliated with the protocol(s) reviewed in this assessment and did not receive any compensation from the protocol(s) or their affiliated entities for this work.

The information provided should not be construed as legal, financial, tax, or professional advice.

[TokenLogic]

We are directionally aligned with this proposal and suggest a more conservative initial implementation:

• wstETH: 30-50bps Base increase
• wETH: 25bps Slope1 increase

Based on our close work with several teams and large investors, we offer the following insights on expected near-term developments:

• Increased wstETH deposits driven by demand for USDS liquidity; and
• Continued demand for ezETH, though at a reduced growth rate.

The Lido instance of Aave v3 is currently the only lending market in DeFi with significant native wstETH yield, making it particularly attractive to large wstETH holders who prioritize concentration risk management and are often limited to top-tier lending protocols. The USDS D3M provides deep liquidity at competitive rates, while the ezETH/wstETH eMode supports a native wstETH deposit yield. For these reasons, we expect continued growth in wstETH deposits over time.

With a substantial amount of wstETH confirmed for imminent deposit, we anticipate fluctuations in wstETH utilization in the near term. While ezETH supply cap increases will support further reserve growth, our discussions suggest this demand may taper slightly, with a large portion of the pent up demand already deployed. Over time, we expect equilibrium to develop between ezETH/wstETH yield strategies and wstETH holders seeking stablecoin liquidity or yield through wstETH/wETH strategies.

Our recommendation is to increase the wstETH Base parameter by 30-50bps, which is approximately half, or slightly less, than the current proposal. We also suggest a small 25bps increase in the wETH Slope1 parameter, which would allow some wstETH deposit yield to benefit wETH depositors. The Aave DAO is presently directing most of its rewards budget to wETH depositors, so increasing the native wETH yield would support a gradual tapering of rewards emissions. This could potentially extend the rewards schedule, reduce overall costs, or enable budget reallocation to other growth initiatives.

We recommend this smaller wstETH Base increase paired with a wETH Slope1 adjustment now, allowing the market to stabilize before considering further increases to the wstETH and wETH borrow rates.

Following the recent tapering of wstETH rewards, these rewards are scheduled to end in the coming week and will not be renewed.

[ChaosLabs]

Summary

Chaos Labs supports the proposal to adjust the Base Rate for wstETH on Aave v3’s Lido instance. We recommend holding Slope 1 at its current rate, citing recent utilization trends and market rate data. The proposed adjustments are expected to increase capital efficiency in the Lido pool without adversely impacting borrow demand or supply rates.

Motivation

The proposed changes involve increasing the Base Rate to 1% and Slope 1 to 3% within the Lido instance on Aave v3. The adjustment to the Base Rate is expected to support the pool’s capital efficiency by generating additional yield for wstETH depositors while maintaining competitiveness for borrowers. This adjustment also aligns with the DAO’s objective of reducing external subsidies by replacing them with yield generated by borrowing demand.

Since the ezETH launch, the wstETH supply rate has increased significantly. Currently, the pool operates with a utilization rate near 50%, and the wstETH borrow demand incentives have driven the effective supply APR to approximately 0.65%. The future launch of stable borrowing E-Modes for wstETH, as noted by Token Logic, will further increase the pool’s attractiveness to new suppliers. Consequently, an influx of new wstETH supply is anticipated, which may impact the equilibrium of supply and borrow demand.

Given the current environment, increasing the Base Rate to 1% can help maintain a stable wstETH supply rate during the expected influx of supply without exerting excessive pressure on borrower costs.

Slope 1

While we support the proposed 1% Base Rate, Chaos Labs recommends maintaining Slope 1 at its current 2.25% rather than increasing it to 3%. Recent data, as shown in the chart, shows that ezETH’s underlying rate stabilized around 4%, following an initial spike to 6% when EIGEN rewards first were compounded into the ezETH rebases. Additionally, using Pendle PT to estimate the market’s expectation of Renzo points values, we obtain an implied APY for ezETH of approximately 5.75–6%. With wstETH’s underlying APY at 3%, we suggest keeping Slope 1 as is to avoid raising borrowing costs excessively. This approach would align the wstETH total borrow rate with a margin of 50 bps below the ezETH implied rate at UOptimal, balancing borrow costs and implied underlying rate.

Revenue

The adjustment of the Base rate substantially boosts DAO revenue by increasing the borrowing cost for wstETH. Based on current pool utilization and the recommended parameters, the total amount paid by wstETH borrowers would rise from $4.6M to $8M, resulting in an additional $170,000 in revenue for the DAO.

Recommendation

We recommend adjusting the Base Rate as proposed while retaining the current Slope 1 to avoid excessive borrowing costs that may impact demand. Chaos Labs will monitor these parameter adjustments post-implementation, reviewing supply caps and utilization rates to align with the market’s demand.

Proposed Parameter Adjustments

Parameter	Current Value	Recommended Value
Base	0.00%	1.00%
Slope 1	2.25%	2.25%
Slope 2	85.00%	85.00%
UOptimal	80.00%	80.00%