Overview
Chaos Labs proposes a temporary adjustment to the WETH interest rate parameters on the Aave V3 Ethereum Core instance, consisting of an increase in UOptimal from 92% to 94% and a concurrent increase in Slope1 from 2.35% to 2.45%. This recommendation is designed to provide short-term relief to borrowers during a period of exceptional market stress, characterized by sharp ETH supply contractions, elevated utilization, and limited responsiveness of demand to higher rates. Importantly, this adjustment is explicitly temporary and scoped to the current market regime, with a clear intention to revert the parameters once supply conditions normalize or leveraged looping activity is reduced.
Motivation
The current WETH market dynamics on Ethereum Core reflect an atypical confluence of negative supply-side and demand-side factors. On the supply side, recent market volatility has triggered significant liquidations and position unwinds, most notably the forced reduction of a large Trend Research position that had over 600k WETH posted as collateral against stablecoin debt.
This unwind materially reduced available WETH supply, amplifying utilization pressure precisely during a period of heightened volatility. This effect has been compounded by broader ETH withdrawals following liquidations, further tightening liquidity in the core pool.
At the same time, yield conditions across LST and LRT markets have deteriorated. The ongoing Ethereum staking queue has led to a meaningful portion of staked ETH temporarily not generating yield, reducing the attractiveness of leveraged ETH looping strategies.
This has coincided with observable depegs across several LST and LRT assets during periods of market stress, increasing caution among suppliers, and the cost of unwinding looped positions. Despite elevated borrow rates, the market has shown a muted supply response.
Technical Analysis
From a risk perspective, several mitigating factors reduce the likelihood that these conditions translate into continued protocol stress. The Slope2 interest rate risk oracle has already adjusted the steepness of the curve above UOptimal, effectively capping the most aggressive rate spikes and preventing runaway borrow costs. As a result, LST and LRT looping positions, while less profitable, remain fully solvent and are not exhibiting severe distress. This has limited forced deleveraging and prevented a negative feedback loop on the asset’s peg.
Additionally, on-chain data indicates that demand for ETH-correlated leverage remains structurally intact. In particular, LRT demand driven by Kelp looping strategies continues to grow steadily, even during elevated market volatility.
In light of these conditions, Chaos Labs recommends increasing UOptimal for WETH on Ethereum Core from 92% to 94% to lower the expected borrow rate at prevailing utilization levels and provide near-term relief to borrowers. To counterbalance this and ensure that utilization beyond the optimal point remains unattractive for routine looping strategies, we also recommend increasing Slope1 from 2.35% to 2.45%. This preserves a clear disincentive to absorb excess utilization above the current UOptimal while smoothing current rate behavior.
This recommendation is explicitly temporary and motivated solely by the current, highly specific market conditions. We intend to closely monitor WETH supply dynamics and staking queue normalization. Once additional supply is added back to the market or leverage naturally unwinds, Chaos Labs will recommend reverting these parameters to their prior configuration to restore a more conservative long-term interest rate profile.
Specifications
| Instance | Asset | Current UOptimal | Recommended UOptimal | Current Slope 1 | Recommended Slope 1 |
|---|---|---|---|---|---|
| Ethereum Core | WETH | 92% | 94% | 2.35% | 2.45% |
Next Steps
We will move forward and implement these updates via the Risk Steward process.
Disclaimer
Chaos Labs has not been compensated by any third party for publishing this ARFC.
Copyright
Copyright and related rights waived via CC0