Given the nuances, Gauntlet would like to clarify that we do not recommend Option 1A. Option 1A is not only less attractive to users given its low capital efficiency (it is even less capital efficient than stablecoin parameters for regular borrowing), but it is also unlikely to achieve lower protocol risk than Option 1.
- Option 1A’s LTV is even less capital efficient than parameters for regular borrowing. For efficiency mode, the parameters should be more attractive than regular borrowing if the community wants to keep e-mode.
- LT (not LTV) is the parameter most relevant for protocol risk. Having the same LT but a much lower LTV reduces attractiveness to users and is unlikely to decrease the protocol risk of bad debt. As such, we do not recommend these tradeoffs as optimal for the protocol.
- Unless data to the contrary is provided, lower LTV is unlikely to “protect” users from liquidation.
The proposed LT-LTV spread of 7% in 1A would be higher than the USDC, DAI, and USDT LT-LTV spreads on all sidechains (which is ~5%). 1A’s spread is also higher than the spreads of all blue chip assets (WBTC, WETH). The parameters initialized for USDC on Ethereum v3 also have a very low LT-LTV spread (currently 2%). As such, Option 1A can meaningfully hurt the attractiveness of E-mode.
Here are several more specific instances where Option 1A is less capital efficient for the LTV than even regular borrowing. Option 1A’s LTV is 80%.
- Avalanche v3
- USDC LTV is 82.5%
- Polygon v3
- USDC LTV is 82.5%
- Arbitrum v3
- USDC LTV is 81%
Gauntlet reiterates that LTV settings can easily be sidestepped to put on a riskier position up to the LT. In one sense, extreme LT-LTV spreads can hurt user experience, should users be looking to take on debt at the LT, since they would have to create an extra transaction to withdraw excess collateral.
Gauntlet’s recommendations of the LTV for E-mode are such that the LT-LTV spread is at least slightly more capital efficient for E-mode than regular borrowing, which is why we recommended 3%.
Toggling LTVs lower has minimal impact on the risk profile for the asset. We provide the below analysis and data to show this.
For instance, Aave v2 USDC changed the LTV from 87% → 80% and LT from 89% → 87% on 2022-12-26. The below charts show the USDC balances for users grouped by user LTVs (rounded up) on Aave v2 on 2022-12-10 before this change in LTV, and the USDC balances for users on 2023-03-01.
We can see that a large majority of USDC supply does not borrow remotely close to the LT or the LTV. But if you observe the aggregate behavior of users supplying USDC most likely to be liquidated (with LTV between 80-85%), their positions have not changed at all, suggesting that the LTV decrease did not convince the riskiest users to unwind their position. In fact, USDC balances from moderate LTV borrowers (between 70-75%, or users less at risk for liquidation) flowed towards lower user LTVs, suggesting that these users unwound their borrows, hurting overall protocol capital efficiency. As such, Option 1A’s lower LTV is unlikely to decrease the risk of bad debt, and also unlikely to “protect” the relevant users from liquidation.
As a side note, reducing LTs from 97.5% to 87% requires careful implementation to mitigate the impact on liquidations and user experience. Gauntlet is happy to provide a plan moving forward on how to best structure smaller LT decreases to achieve the full reduction if Option 1 is chosen by the community.
TL;DR: Being conservative is important, but for the reasons above, Option 1A reduces E-mode attractiveness without further mitigating risk. User experience is important - Option 1A’s LTV reduction reduces the usability of E-mode. As such, we view Option 1A as the least attractive option out of the options presented.