Summary
In response to shifts in LRT yields and broader market dynamics, Chaos Labs recommends lowering the target borrow rate for WETH from 2.70% to 2.50%, which will be implemented through the Risk Stewards process. These adjustments aim to restore optimal utilization levels and enhance overall protocol capital efficiency.
Motivation
Over the past month, ETH market dynamics have directly skewed demand characteristics, primarily through the supply channel. WETH deposits have grown materially, strengthening supply-side depth and mechanically compressing utilization and variable borrow rates, which have traded down to ~2%. A proportional recovery has not matched this uplift in deposit-driven liquidity in LST/LRT borrow demand from looping. Borrow-side activity has remained subdued and relatively inelastic, largely reflecting muted ETH price performance and weaker forward carry expectations, which dampen leverage incentives. Under these conditions, as observed via market behavior, maintaining a wider rate spread is warranted to equilibrate the market with higher efficiency and reprice borrowing risk in line with the prevailing macro and on-chain leverage environment.
WETH Rates
Due to the stagnation of borrowing demand presented by users participating in the LRT looping strategies, the observed utilizations for some of the major markets have decreased materially, with the WETH utilization in the Ethereum Core market dropping from 85% to 75%, representing a decline of over 10%, while some markets have sustained strong levels of utilization the overall trend of declining utilizations can be observed below.
As utilization levels across a broad set of WETH markets have declined in the past months, the borrow rate profiles of the assets have shifted accordingly, with the volume-weighted average of the market rates decreasing by 50 basis points.
WETH on Avalanche
In line with the overall adjustments of the target WETH borrow rate, Avalanche instance requires additional attention, as the imminent launch of rsETH in the coming days, it marks the first case where an LST or LRT obtains access to WETH borrowing demand within the instance, necessitating a reform in the underlying interest rate curve in accordance with the thin margins associated with staking rates. The initially configured risk parameters were applied here, referencing persistently elevated borrowing demand stemming from the directional exposure to the AVAX/WETH pair trade that was obtained, which has since subsided.
Although some aggregate demand persists through BTC.b collateralization, we recommend aligning the target interest rate at UOptimal to 2.5%, down from its previous high of 4.7%.
Recommendation
Given the compression in WETH borrowing demand and the decline in utilization across WETH markets, we recommend reducing Slope 1 for WETH/ETH markets on Aave V3 to 2.50% to restore utilization and capital efficiency. Lowering Slope 1 will better align borrow costs with current LST/LRT yields and the weaker leverage appetite observed on-chain, improving the attractiveness of looping. This adjustment helps re-anchor utilization toward target levels, supports sustainable protocol revenue, and maintains consistent borrowing conditions with broader market conditions.
Specification
| Instance | Asset | Current Slope 1 | Recommended Slope 1 |
|---|---|---|---|
| Ethereum Core | WETH | 2.60% | 2.50% |
| Arbitrum | WETH | 2.60% | 2.50% |
| Linea | WETH | 2.60% | 2.50% |
| Plasma | WETH | 2.70% | 2.50% |
| Avalanche | WETH.e | 3.70% | 2.50% |
| Optimism | WETH | 2.60% | 2.50% |
| BNB | ETH | 2.70% | 2.50% |
| Scroll | WETH | 2.70% | 2.50% |
| Gnosis | WETH | 2.70% | 2.50% |
| ZkSync | WETH | 2.70% | 2.50% |
| Instance | Asset | Current Base | Recommended Base |
|---|---|---|---|
| Avalanche | WETH | 1.00% | 0.00% |
Next Steps
We will move forward and implement these updates via the Risk Steward process.
Disclosure
Chaos Labs has not been compensated by any third party for publishing this AGRS recommendation.
Copyright
Copyright and related rights waived via CC0.