Thanks all for the additional thoughts and suggestions for our IR proposal. To reiterate, we aim to encourage more WETH/WMATIC Emode borrowing in order to increase revenue for Aave, as well as to improve the risk profile for Ethereum and Polygon LSTs. Staking yields have been declining, leaving insufficient ROI for users looking to put on recursive borrowing strategies.
We echo @MarcZeller that a well-designed, automated mechanism for slope 1 to track LST yield will bring significant improvement. Designing such a mechanism is necessarily complex, and we give brief thoughts below.
Regarding borrowing behavior for v2 markets, our proposal aims to prevent WMATIC and WETH supply from flowing backward from v3 into v2. Promoting continued migration from v2 to v3 markets can naturally follow up on this proposal.
On setting slope 1 below LST staking yield
We continue to recommend setting slope 1 to 3.3% for WETH and 4.3% for WMATIC. The current 3.8% slope 1 for WETH is below rETH yields and in line with average yields for wstETH through August 2023. The current 6.1% and proposed 4.6% slope 1 for WMATIC are also significantly higher than the current 4.2% yield for stMATIC.
- Enables the most flexibility for all LSTs to successfully participate in recursive borrowing strategies, which will reduce dependency on LST liquidity for liquidations, thereby improving their risk profile.
- Staking yields vary among LSTs; in particular, rETH had a roughly 3.2% annual yield throughout June-July 2023.
- LST liquidity has been declining, as noted in our original forum post.
- Provides buffer for profitable recursive strategy in the event LST yields decline, allowing borrow rates to be “ahead” of the market, and also reduces the sensitivity of WETH/WMATIC utilization to staking yield changes.
- LST yields have been declining over the past few months, as noted in our original forum post. As an example, rETH yield currently sits at ~3.5% APR as of 2023.08.25.
- Finally, given Slope 2 at 80%, no excess risk with the equilibrium utilization > Uopt.
- Under the proposed change (setting slope 1 to 3.3%), equilibrium utilization will not be materially higher than Uopt (less than 1% greater than Uopt).
| protocol | symbol | New Utilization (equilibrium borrow rate = current borrow rate) | New Utilization (equilibrium borrow rate = max historical LST yield, past 90 days) |
|---|---|---|---|
| aave_v2 | WETH | 0.8005 | 0.8043 |
| arbitrum_aave_v3 | WETH | 0.8004 | 0.8043 |
| ethereum_aave_v3 | WETH | 0.8001 | 0.8043 |
| optimism_aave_v3 | WETH | 0.8004 | 0.8043 |
| polygon_aave_v3 | WETH | 0.5303 | 0.8043 |
| polygon_aave_v2 | WMATIC | 0.4171 | 0.7523 |
| polygon_aave_v3 | WMATIC | 0.7275 | 0.7523 |
On stMATIC/MaticX/WMATIC behavior
With the current staking APR for stMATIC at 4.2%, WMATIC borrowing APR at 5.5%, and WMATIC incentives at 0.3% APR, users currently are not seeing ROI for the recursive borrowing strategy, even with the current incentives.
This is reflected in the changing borrow distribution over time against stMATIC collateral. Currently, 55% of borrows supported by stMATIC are not in Emode, compared to 45% in Emode.
Reducing Slope 1 for WMATIC is the most effective method to revitalize WMATIC borrowing demand. We reiterate our recommendation to lower Slope 1 to 4.3% in order to facilitate more WMATIC borrowing against Polygon LSTs. As noted above, this will not only increase revenue from WMATIC borrowing, as calculated in our impact table above, but also improve the risk profile of stMATIC and MaticX by reducing dependency on Polygon LST liquidity for liquidations.
On automated mechanism to enable slope 1 on WETH and WMATIC to track LST yield
Creating a well-designed mechanism to facilitate strong and healthy WETH, WMATIC borrowing is the most natural method to preserve optimal utilization. The challenge here is that insufficiently designed automated targeting mechanisms have their tradeoffs, and can introduce potential attack vectors analogous to JIT liquidity attacks for Uniswap. These attack vectors essentially allow for a strategic user to profit and seize higher yield at the expense of less sophisticated lenders, which over time may negatively impact the protocol. We provide a more in-depth response here.