[ARFC] Prime & Core Instance - wstETH Reserve Update

[ACI]

[ARFC] Prime & Core Instance - wstETH Reserve Update

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[ARFC] Prime & Core Instance - wstETH Reserve Update
author: @ACI
created: 2024-11-28

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ARFC has been updated with latest Parameters from Risk Service Providers 2024-12-04

Summary

The publication using the Direct-to-AIP process, proposes increasing the capital efficiency of the wstETH Reserve on both Prime and Core instances of Aave v3. This is a Direct to AIP proposal.

Motivation

Prime Instance

The addition of ezETH has resulted in over $620M in direct deposits and approximately $520M in wstETH debt. With yield from EIGEN decreasing and Renzo’s Season 3 rewards nearing expiration, this publication proposes amending the wstETH Reserve parameters to enhance capital efficiency and support user retention.

We have engaged with several builders and investors with significant capital deployed on the Prime instance. Currently, leveraged ezETH/wstETH users are primarily sustained by Renzo’s Season 3 rewards, which are set to expire soon. While an additional $100M of USDS is expected in the coming days, this alone will not be sufficient to retain existing users.

Core Instance

Based on strong demand for wstETH following the rsETH onboarding, this proposal, when implemented, will make a larger portion of wstETH liquidity available.

Discussions with the Kelp team and various investors indicate significant demand wstETH deb by rsETH holders. To accelerate Aave’s growth, the Uoptimal on the wstETH Reserve is be adjusted higher to make available a greater portion of the wstETH liquidity.

Specification

The corresponding AIP when executed will implement the following changes.

ARFC has been updated with latest Parameters from Risk Service Providers 2024-12-04

Prime Instance

wstETH Reserve

Parameter	Current Value	Proposed Value
Uoptimal	80.00%	90.00%
Base	0.00%	0.00%
Slope1	2.25%	1.75%
Slope2	85.00%	85.00%

Core Instance

wstETH Reserve

Parameter	Current Value	Proposed Value
Uoptimal	45.00%	80.00%
Base	0.00%	0.00%
Slope1	2.00%	1.75%
Slope2	80.00%	85.00%

Disclosure

This proposal is directly powered by ACI (Aave Chan Initiative). ACI did not received compensation for creation of this proposal.

Next Steps

1. Using the Direct-to-AIP process, submit a proposal for vote.

Copyright

Copyright and related rights waived via CC0.

[LlamaRisk]

Summary

LlamaRisk supports the proposal. The end of Renzo’s Season 2 rewards program is expected to greatly reduce the profitability of the ezETH/wstETH leveraged-looping strategy, which is currently the main driver behind ezETH’s growth on Aave. For instance, the ezETH Yield Layer product of CianProtocol currently offers 31.41% APY. Once that yield is reduced to more reasonable levels, users can benefit from the high yields offered by the sUSDe Stablecoins liquid E-mode. The proposed increase in uOptimal will help compensate for this effect and retain the ezETH supply.

Source: CianProtocol ezETH Yield Layer, December 2nd, 2024

While a higher uOptimal increases the capital efficiency of wstETH, generating more revenue for the Aave DAO, it also increases the severity of a potential bad debt scenario with wstETH as debt. However, the primary use case for wstETH on both the Core and Prime instances are LRT/wstETH leveraged-looping scenarios. Since LRTs are correlated to wstETH, the liquidation risk is reduced significantly. For this reason, we believe this change would not materialize into a higher risk for the Aave DAO. If the main use case for wstETH borrowing were to change, then such a high-uOptimal would have to be reassessed.

	wstETH Core instance	wstETH Prime instance
ETH Correlated Collateral	98.54%	100%

wstETH Core instance

For wstETH on the Core instance, we analyze a scenario where the utilization remains the same after implementing the proposed changes (max utilization sensitivity) and another where the borrowing rate remains the same (max borrow rate sensitivity). We found that the borrowing rate could decrease to a minimum of 0.29%, and the utilization could increase to 26.97%.

	Utilization Rate	Borrow Rate
Current	13.13%	0.59%
Max utilization sensitivity	(=) 13.13%	(-) 0.29%
Max borrow rate sensitivity	(+) 26.97%	(=) 0.59%

wstETH Prime instance

Again, for wstETH on the Prime instance, analyze a scenario where the utilization remains the same after implementing the proposed changes (max utilization sensitivity) and another where the borrow rate remains the same (max borrow rate sensitivity). We found that the borrowing rate could decrease to a minimum of 1.25% and that the utilization could increase to a maximum of 90%, corresponding to the proposed new uOptimal.

	Utilization Rate	Borrow Rate
Current	64.26%	1.82%
Max utilization sensitivity	(=) 64.26%	(-) 1.25%
Max borrow rate sensitivity	(+) 90%	(=) 1.82%

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.

[ChaosLabs]

Summary

Chaos Labs supports the proposal to reduce Slope 1 for wstETH in Aave v3 Ethereum Main and Prime instances to 1.75%. Additionally, we support the increase of UOptimal to 80% in the Main market. However, we recommend maintaining the UOptimal parameter in the Prime instance at its current level to ensure sufficient liquidity for unwinding market positions and mitigating illiquidity risk.

Motivation

Slope 1

Prime Instance

The reduction of Slope 1 for wstETH in the Prime Instance is crucial for maintaining the profitability of looping strategies. With the impending expiration of Renzo rewards, the implied APR for ezETH is projected to decline significantly, stabilizing near the underlying APR of 4.3%. When combined with the underlying wstETH APY of 2.9% and its current borrow rate of 1.9%, ezETH looping strategies will no longer be profitable. This likely leads to a substantial unwinding of these positions.

Reducing Slope 1 from 2.25% to 1.75% would lower the borrow rate to approximately 1.55%, making looping positions more viable. This adjustment will allow for an orderly unwinding of positions and reduce the risk of abrupt supply shocks in the Prime instance.

Core Instance

In the Main market, similar dynamics apply, particularly for positions collateralized by rsETH. While the current implied yield for rsETH remains sufficiently high at 5.14% to sustain profitable looping, the underlying APR of 3.9% indicates a potential risk of future unwinding as yields normalize. Lowering Slope 1 to 1.75% would mitigate this risk by keeping borrowing costs manageable.

However, the current utilization rate of wstETH in the Main market is only 18%, while the wstETH market maintains significant liquidity. As a result, the proposed Slope 1 adjustment is not immediately necessary. Nonetheless, the combined impact of reducing Slope 1 and increasing UOptimal will substantially lower the borrow rate, further incentivizing looping strategies involving rsETH.

UOptimal

Prime Instance

We recommend maintaining the current UOptimal parameter for the Prime instance due to the high concentration of supply in this market and the larger-than-average size of looping positions.

Raising UOptimal to 90% would expose the market to significant illiquidity risk, particularly as looping strategies unwind. The top supply position in the wstETH market represents 14% of the current supply, making it impossible to unwind it with a 90% market utilization.

Moreover, with the anticipated listing of rsETH in the Prime instance, we expect increased demand for wstETH borrowing, which will naturally drive utilization toward the current UOptimal. Keeping UOptimal unchanged ensures sufficient liquidity to accommodate withdrawals and supports stability during the transition.

Core Instance

In contrast, increasing UOptimal to 80% in the Main market is a reasonable adjustment given the large pool of available liquidity. At this level, the buffer remains adequate to handle withdrawals while improving capital efficiency. However, the increase in UOptimal will lower the wstETH borrow rate further, reaching a rate of 0.25% given the current market conditions. As previously mentioned, this adjustment will also incentivize rsETH looping, supporting Aave’s objective of increasing activity in the LST market in the Ethereum Main Instance.

Specifications

Chaos Labs supports the proposal with the following parameters:

Prime Instance

wstETH Reserve

Parameter	Current Value	Proposed Value
Uoptimal	80.00%	80.00%
Base	0.00%	0.00%
Slope1	2.25%	1.75%
Slope2	85.00%	85.00%

Core Instance

wstETH Reserve

Parameter	Current Value	Proposed Value
Uoptimal	45.00%	80.00%
Base	0.00%	0.00%
Slope1	2.00%	1.75%
Slope2	85.00%	85.00%

[ACI]

Thank you @LlamaRisk and @ChaosLabs.

AIP is now live, you can check it here.

We encourage everyone to participate.