Summary
Chaos Labs provides the following set of recommendations to stabilize the Aave V2 Ethereum stablecoin markets:
- Reduce Reserve Factor from 85% to 70% on all stablecoin markets
- Reduce USDT Slope2 from 100% to 60%
- Reduce DAI Slope2 from 75% to 60%
Motivation
As visible from the chart below, representing the 7-day average interest rates of USDC and USDT on Aave V3 Ethereum, the most liquid market available, we have observed a significant increase in borrowing demand on the broader market, leading to sustained higher rates for stablecoins across all Aave instances.
This surge in demand was particularly impactful on the assets within the Ethereum instance of Aave v2, given its active deprecation through the gradual increase of the reserve factor parameter. This has effectively skewed the adequate alignment of incentives between suppliers and borrowers within the market, as otherwise perceived in V3. The chart below shows the 1D MA supply and borrow rates for USDC and USDT on both Aave V2 and V3 Ethereum deployments.
Each dashed vertical line represents a change in RF. Following the most recent change on October 23, DAI, USDC, and USDT borrow rates have surged, sometimes breaching 100%. However, because RF is now set to 85%, supply rates have not kept pace, leading to extremely large differences in supply and borrow rates, as depicted in the chart above.
As observed below, previous increases in the RF within the Aave V2 Ethereum instance effectively deprecated the market and incentivized stablecoin withdrawals. Despite utilization rates remaining close to their respective UOptimals, the reduced supply rates caused by higher RF levels were sufficient to drive liquidity out of the pools. This demonstrates the effectiveness of RF adjustments in influencing market supply dynamics.
The reduction in supply has been relatively orderly but has outpaced the decline in borrows. This trend is largely due to stablecoin suppliers migrating to V3, driven by elevated demand. As a result, utilization rates have risen further, underscoring the need for a reduction in RF to attract supply back into the market and stabilize borrow rates.
Overall, the recent increase in RF coinciding with the broad market rally has contributed to a sharp rise in borrow rate volatility and supply migration, contracting available liquidity, increasing debt position interest accrual, and degrading the Aave V2 user experience.
While the Aave DAO aims to gradually deprecate Aave V2 in favor of V3, the most recent increase has unnecessarily destabilized the V2 stablecoin markets.
Recommendation
DAI, USDC, USDT Reserve Factor
We recommend rolling back the RF to a level that appropriately reduces the distance between supply and borrow rates to ensure that utilization does not remain above UOptimal for sustained periods of time. While there are other confounding factors, we find that all RFs, since 70%, have effectively reduced the overall amount of stablecoins supplied and borrowed on Aave V2 Ethereum.
The chart below shows the supply rate based on borrow rates. The bottom half shows the difference between the hypothetical 70% RF supply rate and the observed rate. For example, USDC’s supply rate would currently be 12%, 7 percentage points higher than the observed rate. Allowing the supply rate to track the borrow rate more closely should help stabilize rates and bring utilization closer to UOptimal.
We recommend pausing RF changes after this change; should the global leverage demand decrease, we may recommend increasing RF again.
Slope2
In another effort to control borrow rates, we recommend reducing the Slope2 for all stablecoins to 60%. Given that the market is contracting, there will likely continue to be periods of over-utilization following large withdrawals, with a delayed drop to UOptimal as users repay their debt. The chart below shows how the proposed Slope2 and Reserve Factor would alter the interest rate curve with respect to utilization, increasing supplier incentives while simultaneously decreasing borrower overhead.
Specification
| Asset | Deployment | Current RF | Recommended RF | Current Slope2 | Recommended Slope2 |
|---|---|---|---|---|---|
| USDC | Aave V2 Ethereum | 85% | 70% | 60% | 60% |
| USDT | Aave V2 Ethereum | 85% | 70% | 100% | 60% |
| DAI | Aave V2 Ethereum | 85% | 70% | 75% | 60% |
Disclaimer
Chaos Labs has not been compensated by any third party for publishing this ARFC.
Copyright
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