Base stable rate oracle update and improvements in Aave V2

Risk
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The Aave V2 protocol implements a more aggressive IR for stable and variable rates compared to V1. Specifically, the risk parameters have been set as follows:

USDC — USDT

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DAI — TUSD

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Borrowers are taking this opportunity to borrow at a lower risk leading to a high share of stable borrows in V2. This is problematic as the stable rate only rebalances under stressed conditions, losing some of the risk management benefits of the variable rate.

The share of stable rates in V2 has significantly increased for all stablecoins:

  • DAI from 18.57% to 65.3%
  • USDC from 29.13% to 69.65%
  • USDT 45.73% to 77.2%

The reason for that is that compared to the market conditions when V2 launched, many new stablecoin farms appeared, which dramatically increased the demand for stablecoins. The current implementation of the Lending rate oracle cannot keep up with the ever changing market conditions.
This shows to be unhealthy in the long term: too aggressive stable rates fail to attract new liquidity, which dampens the protocol growth and imposes more UX overhead (more difficulty to withdraw liquidity as there is high utilization).

The genesis team proposes two solutions:

  1. the short term fix is to manually override the lending rate oracle (which is still under the control of the Aave genesis team) and impose a base stable rate of 7% (against the current 4%). A base that is almost twice as high will at the same time disincentivize stable borrowing for the short medium/term, or provide higher APY for LPs if the borrowers still choose to borrow at stable.

  2. The long term fix is to get rid of the Lending rate oracle completely by algorithmically set the spread between the stable rate and variable rate. This can be achieved by calculating the ratio

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Where Ds is the total debt stable and Dv is the total debt variable. When R > 1, it means more of the reserve is being borrowed at stable, which increases the spread between stable and variable for new loans. When R < 1, the spread can be lower, to incentivize stable rate borrowing. The equation for the spread can be adjusted to target whatever value of R.
This removes the need for the lending rate oracle altogether, which also reduces the centralization risk and decreases gas costs.

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Update on this front:

  • The design of the new IR strategy has been completed and an implementation is in progress.

  • In the meantime, the demand for stablecoins increased further, requiring an adjustment of the Lending rate oracle. As a consequence of that, the rate oracle will increase of 2 points (from 7% to 9%) for USDC and 3 points (from 7% to 10%) for DAI, TUSD and USDT

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I think this approach endangers the protocol.

If you remove stable borrow, you give competitors a massive point of differentiation which, quite frankly, I would leave the protocol to obtain.

As it stands currently, borrow rates are beginning to make the protocol differentiated against competition - for a second time - in a negative way. While there may be technical reasons why “something would achieve X,” I am concerned there is not a long term consumer lens involved in the considerations.

Both of these add easily targeted points of differentiation for any competitor to exploit. At the existing stable borrow rates, I have begun to utilize competitive products.

I urge you to stop this path so I dont have to choose somewhere else. This protocol doesnt exist in a vacuum. It is easily better than competitors in many ways. Don’t make the main product offering uncompetitive.

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