On the whole, Gauntlet agrees that technologies such as this automated IR can be valuable additions to the Aave protocol. A dynamic interest rate that can adjust in response to a number of factors could optimize capital efficiency in a manner that is equivalent to credit scoring, and also reduce risk caused by a dearth of available reserve liquidity.
However, automated IR mechanisms do have their tradeoffs. We show in our research on dynamic rate curves that the deterministic nature of this automated IR mechanism - as evidenced by the constant nature of marginal increase/decrease in IR outside of the target utilization bounds - could introduce potential attack vectors analagous 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. This over time may reduce overall liquidity on protocols, impairing the capital efficiency of the protocol. For instance,
- A strategic user adds a large amount of demand and raises utilization rates by opening borrow positions, causing the interest rate to spike dramatically.
- The choice of how much of a spike was caused allows the strategic user to sequentially reduce demand (repaying a portion of the opened borrow) and increase supply in such a way that the interest rate and utilization are stationary.
- After a number of blocks, the strategic user returns the utilization to the level prior to opening loans.
At a high level, we find that the reducing the reserve factor below certain thresholds can negate attacker profitability. We have also identified that considering supply and demand elasticities may help with this IR param optimization, especially with the reserve factor and optimally balancing protocol revenue. As a result, models for these elasticities and/or their results can be fed into future automated IR mechanisms to make them more robust against potential attacks and manipulations and disincentivize adversarial actors.