[ARFC] wETH & wstETH - Borrow Rate Updates

[karpatkey_TokenLogic]

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title: [ARFC] wETH & wstETH - Borrow Rate Updates
author: @karpatkey_TokenLogic
created: 2024-10-21

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Summary

This publication proposes increasing the Slope1 parameter by 25bps for wETH on Lido instance and reducing wstETH Slope1 parameter on the Main instance of Aave v3 on Ethereum.

Motivation

When ezETH is onboarded, we expect an organic wstETH deposit rate to emerge. In response, this proposal intends to direct a portion of this yield to wETH deposits by increasing the wETH Borrow Rate (Slope1).

The resulting increase in wETH deposit rate is expected to enable the DAO to revise lower the ETH deposit liquidity mining rewards.

Users with leverage long wstETH and short ETH positions are expected to generate a return exceeding pre-wstETH liquidity mining rewards being initiated.

With the goal of encouraging user to borrow wstETH on the Main instance of Aave v3, the wstETH borrow rate will be lowered. The anticipated rsETH collateral and wETH debt eMode category is expected to create demand for wstETH debt. Given the size of the wstETH reserve the Uoptimal is not being increased by this propsoal.

After monitoring how the market responds, future borrow rate adjustments across the Aave v3 instances on Ethereum will be assessed and any change presented for discussion.

Specification

The Lido instance wETH Slope1 is to be revised as follows:

Asset	Parameter	Current	Proposed	Change
wETH	Base	0.00%	0.00%	0.00%
wETH	Slope1	2.50%	2.75%	+0.25%

The Main instance the wstETH Slope1 parameter is to be revised as follows:

Asset	Parameter	Current	Proposed	Change
wstETH	Base	0.25%	0.00%	-0.25%
wstETH	Slope1	4.50%	2.00%.	-2.50%

The wETH Slope1 adjustment will only be presented as an AIP when market conditions are favourable post onboarding ezETH.

Disclosure

TokenLogic and karpatkey receive no payment for this proposal.

Next Steps

Direct-to-AIP

Copyright

Copyright and related rights waived via CC0.

[LlamaRisk]

Summary

LlamaRisk supports this rate update. The increased WETH Slope1 parameter enables the removal of liquidity incentives, as organic WETH borrowing demand on Aave V3 Lido is now sufficient to sustain market activity.

The impact of rsETH collateral onboarding on wstETH borrowing demand in the Aave V3 main market remains uncertain, making it premature to determine if the Slope1 reduction will be sufficient. A stepped approach is recommended.

Based on the proposed changes, we provide calculations showing the expected borrow rate and utilization ranges.

Lido instance - WETH Slope1 rate increase

For WETH on Aave V3 Lido, we analyzed two extreme scenarios with the proposed 25bps Slope1 increase: maximum user sensitivity to borrowing rates and maximum user sensitivity to utilization. Our projections show utilization is expected to decrease from 84.47% to a minimum of 80.65%, while the borrowing rate is expected to increase from 2.48% to a maximum of 2.67%.

	Borrow rate	Utilization
Current	2.48%	84.47%
Max borrow sensitivity	(=) 2.48%	(-) 80.65%
Max utilization sensitivity	(+) 2.67%	(=) 84.47%

LlamaRisk, October 23rd, 2024

Main instance - wstETH Slope1 rate decrease

For wstETH on the Aave V3 main market, we analyzed two extreme scenarios with the proposed 275bps Slope1 decrease: maximum user sensitivity to borrowing rates and maximum user sensitivity to utilization. Our projections show the borrowing rate is expected to decrease from 0.47% to a minimum of 0.09%, while utilization is expected to increase from 2.19% to a maximum of 11.75%.

	Borrow rate	Utilization
Current	0.47%	2.19%
Max borrow sensitivity	(=) 0.47%	(+) 11.75%
Max utilization sensitivity	(-) 0.09%	(=) 2.19%

LlamaRisk, October 23rd, 2024

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 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 strongly supports the proposal to adjust the interest rate parameters for WETH and wstETH across Aave v3’s Lido and Main instances. This proposal is expected to improve capital efficiency in the Lido pool and optimize utilization of wstETH in the Main pool.

Motivation

Lido Instance (WETH Borrow Rate Increase)

The proposal seeks to increase the WETH Slope1 on the Ethereum Lido instance to 2.75%. We believe this adjustment will improve the pool’s capital efficiency and enable the DAO to better redirect WETH supply incentives in the future.

With the anticipated launch of ezETH impacting demand for wstETH, we estimate the wstETH supply rate could be increased by up to 0.09%, based on the proposed ezETH listing parameters.

However, we expect 40,000 ezETH deposits to be sufficient to offset the 0.25% increase in WETH Slope1 proposed. Given the recent integration of compounded EIGEN rewards into ezETH’s underlying APY, we foresee strong borrow demand for wstETH. Therefore, we anticipate that the increased WETH Slope1 will be quickly balanced by the additional supply APY generated from wstETH.

Even without the additional demand from ezETH, users leveraging wstETH yield could still benefit from a looped APY of up to 10%, factoring in the existing wstETH deposit incentives and the proposed WETH borrow rate.

Main Instance (wstETH Borrow Rate Decrease)

The proposal seeks to lower the wstETH Slope1 on the Ethereum Main instance to 2.00% and reduce the wstETH Base to 0%. We consider this reduction effective in incentivizing rsETH/wstETH looping by making wstETH borrowing more attractive. The reduction in Base is particularly beneficial, as it enables rsETH looping to become profitable even with the narrow APY margin between rsETH and wstETH.
Given the current implied yield of wstETH and the proposed listing parameters of rsETH, we anticipate the borrowing rate for wstETH to reach up to 0.17%. This minimal rate will help maintain a favorable environment for users to loop rsETH and wstETH. This approach would also enable users to achieve a maximum looping APY of 15%, well above the market average, thereby driving liquidity and usage in the pool.

Recommendation

We agree with these proposed parameter changes. Chaos Labs will further monitor these parameters post-implementation and recommend supply caps that are in line with them.

Proposed Parameter Adjustments

Asset	Market	Parameter	Current Value	Proposed Value
WETH	Ethereum Lido	Slope1	2.50%	2.75%
wstETH	Ethereum Main	Slope1	4.50%	2.00%
wstETH	Ethereum Main	Base	0.25%	0.00%

Disclaimer

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

Copyright

Copyright and related rights waived via CC0