Proposal: New Aave Token Architecture

Aave community,

At Delphi, we’ve been working closely with the Aave team over the past few months in order to help guide the Aavenomics design, oversee the transition to Aave 2.0 and participate in community governance. As part of this, we’ve been hard at work designing a new Aave token architecture which we believe will enable greater capital efficiency, innovation, and robustness.

You can read the full 32 page proposal here, but we’ve also included a shortened version below. The full report is more comprehensive, includes a lot of helpful diagrams as well as an example model to help illustrate our design in action, so we recommend you check that out instead.

We look forward to receiving feedback from the Aave community on this and iterating together towards the best solution.

Introduction

Aave has become a leading crypto credit platform, with $1.4B in deposits. Impressively, it has both achieved and maintained this without deploying liquidity mining incentives, meaning Aave depositors are loyal users that have chosen to stay despite the more attractive yields offered elsewhere. This is a testament to the quality of Aave’s product and community.

However, we ultimately see lending becoming a “balance sheet as a service” business. This is an extremely competitive market since anyone that has a balance sheet can effectively facilitate lending, as we can see by large tech companies such as Uber, Amazon, Google and many others recently making moves to begin offering financial services. Within the crypto space, upstarts such as CREAM have achieved traction by adding taking on more risk while larger projects such as Yearn and others have also made moves to enter the lending space with a “stablecredit” solution.

While large lending pools such as Aave command some network effects in terms of the superior interest rates they can offer, their current design with a single, undifferentiated capital pool also comes with drawbacks:

  • Capital inefficient by bundling different risks together and offering a blended return, appealing to a narrower capital base

  • Hampers innovation by increasing the potential costs of failed experiments as these can cause contagion and systemic risk.

  • Act as a target for nimble competitors who can either introduce incentives to facilitate vampire attacks and/or take more risks in moving quicker to add new, riskier products

Our goal with this proposal is to continue moving Aave towards being a credit protocol rather than a credit facility. We want Aave to be the go-to platform for launching, growing and managing money markets, taking advantage of Aave’s existing community, liquidity, and scale.

In this way, our goal is to create incentives that enable permissionless innovation to happen on Aave rather than via forks or competitors. With this, we also want to ensure the potential risks from this innovation are siloed off from the rest of the protocol to prevent contagion and systemic risk while allowing innovators greater ownership and potential upside.

Thus, innovators and their early backers are able to reap the majority of the rewards from their innovations, but they must also ultimately bear the risk of its failure. This should also lead to more efficient allocation of capital as Aave holders can select from a broader base of yield opportunities within the ecosystem depending on their particular risk appetites.

At the same time, we must balance this with ensuring these innovators both benefit from and contribute to Aave’s network effects and scale. Crucially, the system must be designed such that innovators cannot exploit Aave by leveraging it initially and later forking away from it, as this would be detrimental to the broader ecosystem.

Most importantly, this design should lead to a better product for users, as Aave is able to add new products faster while keeping the UX simple and ensuring the risks introduced by these new products are insured by those capturing the upside. This effectively enables Aave to leverage its existing liquidity to offer a bundled insurance and credit platform for users; a value proposition that few competitors can match.

Methodology

This proposal will focus on outlining the high-level token architecture and principles we propose could be used to achieve the previously mentioned goals of enabling permissionless innovation, siloed risk and network effects for Aave as an insured credit protocol.

We have purposefully omitted specifics around lower-level details and system parameters in an effort to ensure that initial discussions remain focussed on overall architecture rather than precise numbers. While a model is included, this should be seen as a way to help illustrate the concepts discussed rather than representing anything final or definite.

Provided the community likes the general direction of our proposal and we can come to agreement on the principles of the broader architecture, the Delphi team will set to work on fleshing out some of the important lower-level details. As a next step, we will construct a full model to allow for simulation of different scenarios, releasing this to the community for feedback. Provided this is agreed, the final step is to work on an implementation plan outlining the best way to initially launch this new system.

System Specification

High-Level Description

At a high-level, we eliminate the idea of a system-wide safety pool and replace it with sharded safety pools in the form of aDAOs that underwrite specific, pre-defined risks. Rather than Aave being one set of money markets governed by all Aave holders, Aave becomes an ecosystem with many different sets of money markets being governed by groups of incentivised $AAVE holders.

For comparison, this is a diagram of how Aave currently works:

This is a diagram of our new proposed system:

As we can see, rather than a single pool of Aave holders governing all Aave markets and a single safety pool backstopping all Aave markets as in the first diagram, we now have segregated capital pools (represented by “aDAO 1” and “aDAO 2”) governing and backstopping the risk for their own money markets (represented by “aDAO 1 Money Markets” and “aDAO 2 Money Markets”).

Similarly, rather than fees being paid to all Aave holders, each aDAO earns its own fees based on the performance of the money markets it operates. aDAO token holders (i.e. Aave holders who stake to a specific aDAO) are entitled to 80% of the fees generated by that aDAO. Aave holders who stake to the ecosystem reserve receive 20% of the fees earned by each aDAO as payment for providing the infrastructure, governing the system, and bootstrapping initial liquidity.

Note: These are preliminary numbers included for illustrative purposes and liable to change based on feedback and/or further research. It is even possible that rather than a fee share, Aave instead captures value via $aDAO token ownership instead.

Crucially, while the aDAOs govern and backstop risk for their own money-markets, the user interacts with the Aave front-end and smart contracts. Thus, although aDAO holders have certain predefined rights and obligations towards the money markets they govern, Aave itself controls the smart contracts and consequently the user relationship and deposits.

Overview

Lenders and borrowers have access to a wide range of products on Aave. In the background, these products are operated by different aDAOs which are themselves governed and backstopped by subsets of incentivised Aave holders. Aave holders can therefore deploy capital to a variety of opportunities within the Aave ecosystem, making decisions based on their specific risk-reward profiles. To realize this goal, we propose the following structure:

  • $AAVE holders can either:

  • Stake $AAVE into the ecosystem reserve, receiving $stkAAVE entitling them to govern the reserve and earn fees generated by it

  • Stake $AAVE into one or many aDAOs, receiving $aDAO tokens

  • If an $AAVE holder stakes $AAVE into aDAO1 he or she is locked up for a period of time and receives $aDAO1 tokens issued on a bonding curve with $AAVE as the reserve asset. Use of the bonding curve has many benefits, including liquidity and encouraging efficient pricing of aDAO risk

  • The exchange rate of $AAVE to $aDAO tokens depends on the bonding curve of that aDAO

  • The $aDAO1 holder now has governance power within aDAO1, including:

  • Determining key parameters described later on in this document

  • Determining how to allocate the $AAVE in their capital pool, including the safety pool (which must be put into safe investments such as Balancer pools) as well as $AAVE in the treasury

  • The $AAVE in an aDAO’s safety pool will be auctioned off to make depositors whole in the event of undercollateralized or delinquent loans. This is described in more detail later on in the document

  • $aDAO1 tokens can also be staked on other platforms, but while the $aDAO1 tokens are staked the holder cannot engage in governance

  • The $AAVE tokens are a backstop to the tokens that are lent within the aDAO (the tokens available on each aDAO are determined by the aDAO (ex. ETH, USDC, DAI etc.)

  • $AAVE is the reserve token for the Aave ecosystem, backing up all $aDAO tokens. In addition, it has ultimate governance rights over all aDAOs and over the ecosystem reserve, which will itself include $aDAO tokens

Ecosystem Stakeholders

The Ecosystem Stakeholders are the following:

● $stkAAVE Holder: Stakes their $AAVE, receiving $stkAAVE entitling holder to govern the ecosystem reserve, which receives 20% of the collective aDAO earnings and may own assets such as $aDAO tokens.

● $aDAO1 Holder: Earns 80% of the lending origination fees from aDAO1 as well as benefiting from potential price appreciation in $aDAO1. Backstops risk in aDAO 1

● $aDAO2 Holder: Earns 80% of the lending origination fees from aDAO2 as well as benefiting from potential price appreciation in $aDAO2. Backstops risk in aDAO 2

● aDAO1 lender: Lends from money-markets governed and backstopped aDAO1

● aDAO1 borrower: Borrows from money-markets governed and backstopped by aDAO1

● a aDAO2 lender: Lends from money-markets governed and backstopped by aDAO2

● aDAO2 borrower: Borrows from money-markets governed and backstopped by aDAO2

Benefits

This design has several benefits:

  • Capital Efficiency: Tranching risk increases capital efficiency, allowing $AAVE holders to have access to different yield opportunities based on their risk-reward profiles. Holders who want the least risk can stake to the ecosystem reserve which doesn’t backstop any risk, users who want low risk can stake to one of the aDAOs that underwrites high-quality assets such as stablecoins/BTC/ETH, and users who want higher risk can take idiosyncratic risk on more speculative or higher risk aDAOs.

  • Faster Innovation: This design enables Aave to move even faster than it already does. Rather than the global safety pool in which any new product introduces the potential of contagion and systemic risk, the tranched model ensures risks are siloed and contained among those who are both willing to bear them and appropriately rewarded for doing so. This means Aave can launch higher-risk, more experimental products while providing higher safety assurances to users and eliminating systemic risk.

  • Better Products: This results in a better product for users who not only have access to a broader variety of products but also have the comfort of bundled in insurance via the bonding curve capital pool. This capitalizes on Aave’s liquidity and security network effects, making it very difficult for smaller competitors to be able to match Aave’s product offering.

  • Open Platform: The ability for anyone to create aDAOs that manage money markets transforms Aave from a credit facility managed by a central entity to a credit platform/protocol in which anyone can permissionlessly spin up money markets. Would-be competitors who see a product gap in the market are encouraged to create aDAOs rather than compete directly, taking advantage of Aave’s existing liquidity and customer base to enable a better product and faster route to market.

Forming an aDAO

In order to form a aDAO, an Aave staker submits an Aave Improvement Proposal (AIP) which specifies the aDAO’s charter and key system parameters. We outline a full list of potential parameters along with descriptions of each one in our longer form proposal linked above.

After formation, any changes to the aDAO parameters are determined by $aDAO holders with the result being submitted to Aave for execution. Any change to a fundamental system parameter means those on the winning side are locked for a predefined time period while losers can exit the system.

Rather than voting for/against it, the AIP must instead attract a minimum quorum of Aave staked to it (e.g. 5%). Upon reaching this minimum quorum, the aDAO is automatically created, with staked Aave being converted into aDAO tokens on the proposed bonding curve and locked for some period of time (e.g. 3 months). Initially, we would recommend AAVE either set an extremely high quorum for creating new aDAOs, operate all new aDAOs itself, or at least retain some level of veto power in order to ensure the quality and legitimacy of aDAOs being created.

aDAO Bonding Curve, Treasury and Balance Sheet

Bonding Curve Design

We suggest $aDAO tokens are issued on a bonding curve with $AAVE as the reserve asset. For simplicity, we’ve assumed a linear bonding curve shape and that all aDAOs utilise the same bonding curve shape.

We recognize that a linear bonding curve is not the optimal design for various reasons. Determining the optimal bonding curve shape is beyond the scope of this paper and will be part of the workstream in phase 2 once the architecture has been agreed upon.

Capital Pool as Insurance

Similarly to Nexus Mutual, the capital in the bonding curve acts as the safety pool that insures aDAO’s money markets against both smart contract and economic risk. In case of delinquent loans or hack, $AAVE in the bonding curve is sold to make depositors whole, reducing $aDAO’s token price. This means Aave can now offer a bundled insurance & credit product to users, increasing its value and fee extraction potential.

The treasury is a separate pool of discretionary capital that $aDAO holders have governance rights over. This capital is not in the safety pool or bonding curve and can be used by the aDAO for ecosystem incentives, yield-generating activities, paid out to $aDAO holders or anything else as determined by governors.

The minimum safety parameter (which is also set by the aDAO governors) determines the mandatory ratio of capital in the bonding curve to system capacity. As the aDAO grows and $aDAO token supply expands, overall system capacity grows alongside it as there is more $AAVE backing the curve. This means, provided the risk is appropriately computed and reflected in the MSP, users will always have access to insured money markets as $aDAO supply should grow alongside system capacity. For $aDAO holders, this also means not all capital in the Bonding Curve will be liquid/withdrawable at a given moment in time since part of it will be a liability in the form of money market insurance for depositors. However, $aDAO holders always have a claim to the $AAVE in the safety pool. If they want to redeem, they will ultimately have to wind down the money markets in order to eliminate the insurance liability.

aDAO Balance sheet - Treasury and Capital Pool

In addition to capital in the bonding curve / safety pool, aDAOs may also build up treasuries which are governed by $aDAO holders. There are multiple ways to for an aDAO to build up a treasury:

  • Divert a percentage of $aDAO token purchases to the treasury

  • Divert a percentage of fees generated to the treasury

  • Charge a withdrawal fee for bonding curve withdrawals and divert a percentage of this fee to the treasury

  • Implement a low maximum safety parameter, meaning capital flowing into the bonding curve gets diverted to the treasury early on

  • Receive a grant from the Aave ecosystem reserve

The aDAO balance sheet can thus be seen as follows:

An aDAO token’s book value is the excess capital in the safety pool above and beyond the amount necessary to satisfy the insurance liability (determined by System Capacity * MSP) plus the amount in the treasury.

As such, the bonding curve price can be rightly seen as the $aDAO’s token’s price floor, with the market price most likely trading above this. This is because the bonding curve price doesn’t take into account the additional $AAVE in treasury which $aDAO holders have rights to (aDAO equity in the balance sheet above).

Ecosystem Reserve and aDAOs

Governance

Ecosystem Governance

At a high-level, $AAVE holders who stake to the ecosystem reserve receive $stkAAVE which entitles them to govern the reserve and receive some yield from that. This should require a lock-up period and be the lowest yield available in the Aave ecosystem since $stkAAVE holders are not backstopping any risk. As mentioned previously, the ecosystem reserve should primarily be used to bootstrap the Aave ecosystem by investing and providing grants to aDAOs, although working capital can also be invested as determined by the governors.

In case of a hack, $stkAAVE holders may choose to use the ecosystem reserve to make depositors in an aDAO or aDAO holders themselves whole. However, it is not obliged to do so as each DAO is fully self-sovereign and liable for its own risks.

aDAO Governance

aDAOs are self-sovereign entities governed by $aDAO holders with a one-token-one-vote system. In order to govern the aDAO, only $aDAO tokens held for at least 7 days are able to vote on any proposal. We propose that voting power scales logarithmically with time tokens are locked for, rewarding longer-term holders with more governance power without leading to excessive concentration. To supplement this, we suggest a reputation system which is specified in more detail in our longer-form proposal.

We propose that any vote that alters a fundamental system parameter (i.e. one of the charter parameters outlined in the “Forming an aDAO" section) locks the winning side’s tokens for an additional 7 days after the vote finishes, with the losing side being unlocked immediately. This ensures that users are able to exit the system if the aDAO no longer operates by the charter they agreed to, with those proposing the change living with the consequences of their decisions.

While the aDAO is self-sovereign, it does not itself control the smart contracts of its money-market. Instead, any decision made by the aDAO is sent to the Aave DAO to ratify and execute. This ensures TVL always sits with Aave, maximising the ecosystem-wide network effects.

AAVE and aDAO Interactions

As a metaphor, the Aave ecosystem reserve can be seen as the holding company while aDAOs are the partially owned subsidiaries. The ecosystem reserve will hold $AAVE tokens and may also hold several $aDAO tokens. In addition, it receives cashflows from all underlying aDAOs, with $stkAAVE holders being in charge of allocating these cashflows to wherever they can achieve the highest returns.

The ecosystem reserve can interact with the aDAOs in a variety of other ways. These are specified in more depth in the “AAVE and aDAO Interactions” and “Ecosystem reserve and aDAO” sections of our longer form proposal.

Protecting from tail risk

While the system works well under normal circumstances, given that all aDAO safety pools/bonding curves are held in $AAVE, a sharp fall in $AAVE price could lead aDAOs to trade under the minimum safety parameter. While this isn’t ideal, it isn’t as bad as it sounds since unlike something like THORChain, there is no immediate way for this to be exploited by bad actors. Rather, it simply means the aDAO is not appropriately collateralised for the technical and market risks it is exposed to.

It’s also worth understanding that there are natural market forces that should help collateralise the safety pool. Assuming the price of $aDAO tokens have intrinsic value based on the discount future value of cashflows they generate and distinct from the $AAVE price, then as $AAVE drops in price, users are able to acquire the same amount of $aDAO tokens at a lower dollar price. This should encourage more $AAVE to flow into the safety pool to take advantage of this.

Nevertheless, crypto markets are rarely efficient and we thus propose a few additional layers of protection for the system:

  • aDAO Treasury: The first layer of defense for an aDAO is its treasury. We propose that if the amount of value in the safety pool drops below the minimum safety parameter, the treasury is automatically transferred into the bonding curve/safety pool.

  • Incentive pendulum: If after transferring the treasury into the safety pool, it still remains undercollateralized, then we propose the following incentive mechanisms:

  • Increase Staking Incentives: $aDAO pools issue $aDAO credit tokens, entitling users who come in to stake while the pool is undercollateralized to receive a larger amount of future $aDAO tokens

  • Reduce System Capacity: If neither solutions work, then we suggest creating incentives to reduce system capacity, perhaps by implementing an increased fee on outstanding loans to incentivize users to pay their loans back.

Implementation

Types of aDAOs

At a high-level, we believe aDAOs should be segregated by their risk-reward profile, perhaps based on Aave’s existing asset risk framework. This allows each DAO to be owned and operated by stakeholders with appropriate risk appetites. In addition to tranching risk, Aave can also use new aDAOs to enable risk siloed experimentation hubs such as the recently proposed DAO to DAO lending.

We suggest, at least initially, each aDAO should have an exclusive license over assets deposited into its protocol as well as the type of lending products it provides. Eventually, we believe it should be possible to open this up, allowing aDAOs to offer similar assets, competing on the way the particular combinations of assets they provide, the speed/quality of governance and/or the risk-reward provided.

Initial aDAOs

Initially, we propose all initial aDAOs will be operated by Aave itself, with the current money markets protocol being split into either one or multiple aDAOs, pending feedback from the community:

  • Single aDAO

  • “Aave Classic”: includes all existing money markets

  • Two aDAOs

  • Aave AA: includes the highest quality collateral ($BTC, $ETH, stablecoins), having a lower safety parameter and consequently lower yield

  • Aave AB: includes lower quality collateral ($YFI, $BAT, $ENJ, $REN, $KYBER, $LINK, $MANA, $MKR, $REP, $SNX, $WBTC, $ZRX)

  • Three aDAOs:

  • Aave asset-backed: includes asset-backed tokens such as stablecoins, WBTC and potentially others such as PAXG.

  • Aave AA: includes the highest quality collateral ($BTC, $ETH, $LEND)

  • Aave AB: including lower quality collateral ($YFI, $BAT, $ENJ, $REN, $KYBER, $LINK, $MANA, $MKR, $REP, $SNX, $WBTC, $ZRX)

Initial $aDAO Distribution

The initial aDAOs will likely be comprised of Aave’s existing money-markets. As such, the initial $aDAO token launch will have to use some fair distribution mechanism to avoid users rushing to frontrun the aDAO bonding curve on launch. We have some ideas around how to do this that we will flesh out at a later stage.

Potential aDAOs

In terms of new aDAOs, there are many potential ideas here. Broadly, the goal should be either to either group together assets with similar risk-reward profiles or allow for experimentation with new kinds of products.

In addition to the aDAOs already mentioned above, these are some other potential ideas for aDAOs:

Risk-tranched

  • Aave asset-backed: Money markets for asset-backed tokens such as stablecoins, $PAXG, $WBTC, $REALT tokens, etc. In addition to traditional risk parameters such as liquidity, volatility, etc, risk framework should include custody risk, technical risk, and others.

  • Aave yTokens: Money markets for yield-bearing tokens including $YUSD, $YETH, $crUSD, $pUNIUSDC, etc

  • Aave BBB: CREAM competitor operating money markets for the long-tail of more illiquid, volatile tokens such as $UNI, $wNXM, etc.

Experiments

  • Aave uncollateralised: Money markets for uncollateralised stablecoin lending. This could have more stringent KYC requirements, operate using open law agreements and/or experiment with on-chain credit history, reputation or prediction markets.

  • Aave DAO2DAO: Money markets for DAO to DAO lending. This could be bootstrapped by Aragon and leading Aragon DAOs.

Risk Framework

Given the fact that aDAOs will be segmented primarily by the risk-reward they provide, combined with the importance of setting an accurate safety parameter for each aDAO to ensure system integrity, it’s extremely important to have robust risk frameworks to assess the risk being taken on by each aDAO.

These can be based on the existing Aave risk asset framework, but we also recommend this is supplemented with specific frameworks for different kinds of assets such as asset-backed tokens which may require bespoke analysis around things like custody risk. We also recommend standards are created to classify the riskiness of different assets in order to be able to accurately group them into the correct risk bucket and corresponding aDAO, as well as to be able to estimate what an appropriate safety parameter looks like.

The goal should be to first settle on a metric that accurately reflects system capacity, i.e. the risk weighted credit exposure that a certain aDAO is taking on. Then, each aDAO will define its safety parameter in relation to that metric, based on its charter and targeted risk-reward ratio.

User Experience

While the aDAO system may seem complex, we believe the majority of this complexity can be abstracted away from users. Provided all aDAOs are appropriately collateralised (which should be guaranteed by the governance process), users don’t care how the money markets are secured and governed, they just care about the variety, quality, and safety of the products they use.

As such, we propose all aDAO money market smart contracts are owned and operated by Aave and displayed on the app.aave.com website, similarly to how any new market would be displayed. Users interact with the money markets as normal and need not be aware of what aDAO is governing those particular markets.

Proposed Roadmap

We propose the following phased roadmap:

  • Phase 1 - System Architecture

  • Discuss the high-level system architecture presented in this document

  • Implement any changes presented by the community

  • Phase 2 - Specification

  • Determine lower-lever system specifications with goal of arriving at a minimum viable design: the simplest design that allows for the system to launch and begin testing assumptions in production. This will include:

  • Bonding curve shape - Model out different bonding curve shapes based on existing Aave data

  • aDAO Risk Framework - Determine the best way to calculate “system capacity” and MSP across the ecosystem

  • aDAO parameters - Model out different withdrawal fees, treasury parameters, etc to figure out optimal initial aDAO design

  • Phase 3 - Implementation

  • Determine the best way to implement the system, including:

  • Which aDAOs to launch first

  • How to conduct $aDAO initial distribution

  • Potential aDAOs to launch later

  • Phase 4 - Additional workstreams

  • Reputation - Design reputation system to be used across Aave ecosystem

  • Ongoing monitoring - Ongoing monitoring of aDAO system health, including determining what metrics to track, etc.

36 Likes

Alright! Love the idea. Risk pooling is a significant issue Aave is facing, and with the advent of V2, starting the discussion with something this powerful and innovative is great to see.

With that said, after reading the full proposal, I’ve got some concerns and questions. Let’s get into it! :beers:

  1. Safety Module:
  • As the protocol expands and more markets are created, the yield increases on the stkAAVE pool, causing an outflow from various aDAO security modules to balance the risk and yield. Does this not reduce the effective value proposition of the Safety Module by reducing the amount of insurance on each aDAO?
  1. Liquidity Thinning:
  • As it stands, Aave governance is incentivized to focus on coming up with effective and efficient risk parameters for tokens.
    Under the proposed model, the creation of new markets with aDAOs is encouraged, wouldn’t this result in a thinning of available liquidity as more markets are built? I.e. With each additional market with a given token, liquidity for that token could potentially be drained from previous markets until a risk/yield equilibrium is found.
  • Expanding on the previous point, as the creation of new markets becomes incentivized over the addition of new assets to existing markets, would it not become more difficult to unlock liquidity in a given token?
    I.e. If a user has a token that is available on market B, but wants to borrow a token only available on market A, this is not possible without incurring the same liquidity thinning problem outlined in the question above.
  • Furthermore, if the liquidity thinning issue is assumed to be true, is it not in the best interest of current aDAO holders to fight against new market additions, which could reduce their liquidity/fees? On the flip side, is it not in the best interest of stkAAVE stakers to push for many new markets, with less regard for risk? For instance:
    i. aDAO1 has significant DAI liquidity, thus, adding the proposed aDAO2 could cause an outflow of DAI to aDAO2.
    ii. Though this would potentially raise the interest rate, it would also decrease total potential borrows/flash loans, and have an adverse effect on fees earned by aDAO1.
    iii. aDAO1 is therefore vehemently fighting againt aDAO2 to maintain its liquidity and fees.
    iv. The stkAAVE stakers are much more accepting of new aDAOs, since their risk is limited to negative price action incurred from aDAO stake slashing, rather than having their own stake slashed. Furthermore, their total earned fees should theoretically only rise, as their earnings are spread among all aDAOs.
  1. Fee distribution:
  • Would having each aDAO as a semi-independent authority collecting its attributed fees result in a reduced ability to concentrate capital in a single, powerful reserve- instead opting for numerous, smaller and less impactful treasuries? If so, wouldn’t this reduce the Aave DAO’s capacity to invest in meaningful growth/talent/etc?
  1. Bonding curve:
  • I fail to see the need for a bonding curve system- would the earned yield not suffice for pricing risk adequately without an added abstraction layer of speculation?
  • Expanding on the previous question, under the bonding curve system, stakers could potentially withdraw less AAVE than they put in without a trigger of the safety module should the aDAO token fall in price. Does this not result in added, speculative risk for stakers, who are already bearing the risk of being insurance providers?
  1. aDAO Governance:
  • Since aDAOs form their own independent markets, how exactly do they benefit from Aave’s liquidity as stated in the proposal? It appears to me that they only rely on Aave to execute proposals. If this is true, what is the incentive to build an aDAO, losing potential fees and governance power to the ecosystem reserve without gaining in liquidity?
  • By segregating the AAVE supply into various aDAOs, are we not reducing the protocol community’s ability to come together for large, sweeping changes across the entire codebase, should the need arise?
  1. Reputation & Voting:
  • An interesting idea, but is the same goal of encouraging participation not achieved by simply using a normal voter delegation system?
  • I somewhat agree with a winning vote lockup, but locking tokens with the FDS system is something I don’t really agree with. I see no reason to enforce this, bar potentially fighting against loaned governance token attacks which even then, could be potentially solved with the winning lockup, or just a general voting short-term lockup. I think the downside of locking liquidity is greater than the benefit.
  • Take this with a grain of salt but, if the DAO awards reputation, couldn’t larger players potentially sway the system in their favor?

I believe it’s fundamentally better to prioritize security and innovation, and though this proposal is aimed at the same goal, I feel as though it’s more of a way to circumvent security in favor of rapid innovation to prevent vampire attacks and maintain market share. I am more in favor of wise risk parameters with more assets in less markets, but with concentrated power and aligned incentives for the entire DAO.

Lastly, take everything I wrote with a grain of salt! The folks at Delphi Digital are waaay more experienced than I am. I’d just like to voice my concerns.

On that note, this was a bit of a brain dump so, if any of these questions/concerns don’t make any sense or if I misunderstood points about the proposal, let me know!

Cheers!

*Edit: Typo!

14 Likes

This is important in my opinion, profiles.

This means Aave can launch higher-risk, more experimental products while providing higher safety assurances to users and eliminating systemic risk.

This could be tricky…

I don’t feel very confortable (it’s a complex post) so i’ll read more than comment

shouldn’t this be “lends to”?

1 Like

This is an excellent proposal and am fully supportive of the high level design.

I had a few questions which would be helpful to clarify:

-The current stkAAVE yield isn’t very high at present, and where this design splits total yield across multiple segments as well as the ecosystem reserve, what mechanism is in place to ensure the yield is constantly adjusting to ensure the necessary supply of staking at each aDAO is met? For example, if there is close to zero participation for the lowest risk/ yield ecosystem reserve, is there any dynamic adjusting incentive to remedy this?

-Splitting the aDAOs for different assets makes perfect sense, but what if there is competition between the DAOs for an asset which is not clearly high or low risk? Clearly it would be sub-optimal to allow both DAOs to allow the asset, but how is this governed if both want to add the asset, and if DAOs have different views on the collateralization metrics around the asset (eg LTV)

-Some of the decision making left to the DAO I think is too complex to be left fully to the community without supporting risk analysis (eg Gauntlet) - most of us are not sophisticated enough to agree on the right parameters especially for new/ higher risk assets without this I think.

-I like the idea of the DXD reputation system - could we consider adding something similar to the YFI strategist fee reward where if an individual adds a new idea/ lending market which accrues fees for everyone the individual themselves is rewarded with X% of all fees…I think this will help to incentivize the community further to make sure they are innovating on behalf of the whole of AAVE.

3 Likes

This is a very promising design, aiming to solve major areas of vulnerability whilst capitalising on Aave’s considerable lead and opportunity. It brings together a number of patterns that fit well in other projects (bonding curves, incentive pendulum), and introduces a new one that I believe will dominate going forward – the core/subcomponent or “franchise” model.

I’ve spent some time going through the past couple of days and will still take time to fully grok it. But I’ve got some initial thoughts:

  • The franchise model does feel natural to me, but I’m curious if you considered any other designs?
  • I am in an aDAO and want to remove my funds, but this would pull capacity below MSR. Presumably I’m blocked from removing my funds?
  • Could the bonding curve accept assets other than $AAVE? This could increase adoption by decreasing required exposure to a foreign asset. Global governance to whitelist accepted collateral – e.g. $ETH and $DAI (if you’re into that).
    • The principle is – should someone using a protocol really need to take on financial exposure to that protocol? The question might be, are the users of a pool the same as the creators? My suspicion is that in many cases, they are.
  • A broader point I want to raise in the Aave community is around external asset ownership. To your point about making Aave more of a protocol I feel that some pool parameters should be open to voting purely by holders of the pool’s assets, and should not require any $AAVE to be held. Could be a change further down the line, but I think this change paves the way well by reducing contagion risk.
  • Did you consider adding some measure of demand to the bonding curve? Currently the aDAO token has a deterministic price floor but I sense there’s an opportunity to bring more determinism as a function of demand. Potentially by taking trailing average fees, or fee levels as a direct input?
    • On that point, and I might’ve missed this, but how are pool fees set? At the risk of looking like a hammer, I sense it might be possible to pull this from the bonding curve.
    • Ironically I suspect that the more that can be deterministically factored in, the better it is for the Aave economy. More determinism → easier to trust → more $AAVE investment → more secure, better prices → more $AAVE investment etc. I think determinism could be a key input to Aave’s (and other protocols’) flywheel and therefore a key vector of defensibility.
  • In the case of a tail risk event, you propose an incentive pendulum. How does this work from a governance perspective? Is the functionality in place for pools by default, and enacted in via vote? Or could there be some more automated mechanism? e.g. reward flow as function of ratio of AUM to MSP.
  • You propose making it such that new pools are created and updated via AIP. My feeling is that for Aave to truly be an autonomous protocol, the aim should be for pool management to be entirely permissionless. This can be seen as an optimisation and introduced later, but I wonder if you think there’s scope for achieving that in this implementation, out of the gate? Or perhaps you feel that total software-mediation here is not desirable at all? If so, would be curious to hear why.
  • Do you have any plans to make introductory content to this proposal available? It’s extremely dense and I think some other formats could help it spread through the community and get to resolution more quickly. (I’ve made a brief attempt on Twitter :sweat_smile:.) Maybe a couple of videos – 1x high-level, 1x detailed – and jumping on the Delphi podcast would help?

I’ll be spending more time thinking about the problems and solution you laid out, but after an initial period of consideration this feels like a solid direction forward for Aave. This proposal gives me even more confidence that Aave can sustain its advantage as the leading provider of decentralised lending.

2 Likes

Hey @Zer0dot, glad you like the idea and really appreciate the thoughtful questions. Will take them in turn.

1. Safety module

  • As the protocol expands, the cashflows accruing to the ecosystem reserve increase. However, these necessarily increase slower than the cashflows to the specific aDAOs, particularly the higher growth ones since the ER receives less cashflows (20% vs 80%) and has a much higher numerator. Also, this doesn’t necessarily mean higher yield for $stkAAVE holders as we don’t believe all cashflows should automatically be paid out to holders but rather be used to build up a reserve / invest into new initiatives as per this proposal. The yield to $stkAAVE holders should always be the lowest available in the ecosystem because $stkAAVE holders aren’t backstopping any risk. Capital which wants higher returns will flow to the aDAOs based on their risk policies and mandates.

2. Liquidity Thinning

I’m not sure if you’re referring to liquidity thinning for the specific money market deposit tokens or for the $aDAO tokens so I’ll address both.

In the case of money market tokens, the proposal doesn’t actually fragment liquidity in money market tokens since each aDAO is granted an exclusive license over assets deposited into its protocol as well as the type of lending products it provides. The aDAO is kept in check by the fact that Aave can revoke its license if it feels like it’s not doing a good job. We are still on the fence about whether eventually different aDAOs can compete on the same assets, but right now we’re leaning towards thinking that the tradeoff in terms of fragmenting liquidity is not worth the added benefit of encouraging more competition to keep aDAOs in check. Especially since every aDAO will face both external competition as well as the possibility of Aave revoking the aDAO’s license, both of which should act to encourage performance.

In the case of $aDAO tokens, the idea is that aDAOs have their own differentiated mandates and resultant risk-return profiles. An aDAO isn’t limited to the tokens/products it initially launches with but will rather seek to continuously add tokens/products that fit with its mandate in order to keep growing.

I don’t see “liquidity thinning” being an issue because a new aDAO should only be launched if there is a ‘gap in the market’ in that no other aDAOs are adequately fulfilling its mandate. While some liquidity may flow from old aDAOs to new aDAOs, this should be a net positive for the ecosystem since it will increase capital efficiency by opening up a greater variety of risk-return opportunities for $AAVE holders and for investors who want exposure to the decentralised credit space.

On the other hand, I think there may be some fighting around which aDAO has “jurisdiction” over a certain asset, especially over time as assets which are initially risky and belong in a given aDAO may become less risky over time such that they belong in another aDAO’s mandate. Relatedly More research needs to be done on this but any decision of this sort should ultimately be decided on by $AAVE holders for the good of the broader Aave ecosystem.

3. Fee Distribution

At a high-level, Aave DAO would no longer be operating money markets but rather governing the aDAOs who themselves operate money-markets. As such, it makes sense that the aDAOs themselves build up treasuries since they will be closest to understanding the needs of their own money-markets. The alternative is extreme inefficiency and bureaucracy with each aDAO spending decision needing to be a proposal approved by $AAVE holders who are not best positioned to understand that aDAO’s needs.

It’s also worth noting that the Aave DAO should still be able to build up a significant capital base via fee flows from the various aDAOs as well as its ownership of $aDAO tokens. In any case, we really need to model this and tinker with it to see what it actually looks like. These parameters aren’t set in stone and are subject to being changed based on the modelling work to be conducted in Phase 2.

4. Bonding Curve

The bonding curve is necessary to incentivise boostrapping of higher-risk, early stage aDAOs by appropriately rewarding early believers. Otherwise, there’s no advantage to taking the risk early since later entrants can simply wait and pay the same price to stake in later once risk is lower / fees are higher. While a bonding curve isn’t the only way to do this, there needs to be some equivalent of a pricing mechanism to incentivise early adopters. For instance, while Nexus Mutual doesn’t use a bonding curve for staking on smart contracts, there is a functionally equivalent price curve which rewards early stakers:

image

$aDAO tokenholders are definitely taking a risk, but this unavoidable in other to create incentives for price discovery as mentioned above.

5. aDAO Governance

As context, there is a minimum quorum for proposed aDAO votes (we suggested 5%) and, provided the vote passes, $AAVE holders that vote for an aDAO will automatically be converted to $aDAO tokens. There are thus several benefits to launching an aDAO vs launching a competitor:

  • Access to Aave’s existing tokenholder base and associated liquidity. This initial capital base allows an aDAO to launch with insured money-markets from the get-go, providing a better product for users.
  • Access to a knowledgable, long-term oriented community to help govern and grow the aDAO from the beginning
  • Access to Aave’s existing integrations, brand and traffic as all aDAO money-markets are listed on Aave.com’s front-end

As a metaphor, an $aDAO can be seen as an Aave franchisee responsible for certain markets/mandates. They benefit from Aave’s brand, infrastructure and know-how, giving away some of the upside in return. The tradeoffs of starting an aDAO vs a competitor are similar in character to the tradeoffs of starting your own burger joint vs buying a McDonalds franchise. In the digital world however, network effects mean the benefits Aave can offer are much greater.

**6. Reputation & Voting **

I would argue some of the same results are achieved, with the difference being a voter delegation system still assumes all tokenholders are involved enough in the governance process to know who it makes sense to delegate their vote to (kind of like the traditional political system). A reputation system, because it starts off centralized, puts most of the onus of initial distribution on the DAO’s team and is more likely to trickle through and end up in the hands of valuable community members.

I’m not sure if I understand your point regarding locking tokens with the FDS system. The idea of Future Days Staked is that it’s a voluntary commitment a tokenholder can make to lock his tokens for X amount of time in order to augment his voting power proportionately. Ultimately, it serves to provide greater influence to less wealthy but long-term convicted $AAVE holders than to more wealthy speculators, rewarding commitment as well as capital.

Reputation is subject to being gamed just as all systems are. The key is to create strong norms around distribution and what constitutes a valuable non-monetary contribution. Regardless, reputation is not the focus of the proposal and will be a later workstream once we’ve agreed on the high-level architecture of the system.

Conclusion

To address your last point, we don’t see this proposal as a way to circumvent security in favor or rapid innovation, but more as a way to enable secure innovation; reducing the potential downside of failed innovation and thus enabling more of it to occur. In all startups, it’s important to shorten the evolutionary cycle as much as possible, making small experiments, iterating and failing quickly in order to progress. This has arguably been Aave’s greatest strength so far and our fear with the concentrated power/capital model is that over time Aave’s size and the potential for contagion will impact its ability to do this.

Overall, really appreciate your contribution @zer0dot . You asked some excellent questions and this is exactly the kind of feedback we need to force us to think deeply and strengthen all aspects of the design. Hope the answers were alright and please feel free to follow up with any more comments, questions or feedback. We’ll make sure we get back to you asap!

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Thanks for this proposal, it is really great work :slight_smile:

I see many advantages in this architecture. Aave needs to evolve to continue embrace rapide pace innovations of DeFi and current structure does not allow to properly scale money market.

Sillos organisation seems to me like decentralizing the risk of each money market which is great. It empowers users and rewards at a better granularity their participation in the protocols market. At their risk.

Bonding curve :
As mentioned by @Zer0dot in his 4/ I also do not like the fact that rescue found liquidity providers will bear price fluctuations and insurance providing risk. A different design in the bonding curve could fix this.

I suggest a logarithmic curve for $aDAO exchanges. It will drastically reduce the risk of price fluctuation after reaching large amounts of founds while maintaining extra avantage for early comers.

Capture d’écran 2020-11-16 à 18.51.00

Initial aDAOS
The Two aDAOs model is ok to me. It gives more choice to users and I assume we do not all expect to bear risk for $BTC as much as $YFI.

aDAO creation
The “stake to create” design seems nice. 5% quorum is nonetheless too much in my opinion. I would suggest 2 or 4% depending of community opinion.


Something interesting in this proposal is the fact that AAVE treasury will be dedicate to builders that will makes us closer to the ghost superstructure of DeFi we want to be.
Rewarding stkAAVE for their risk is not the most efficient utilisation of AAVE funds and your proposal also reasons to me after the recent talks regarding AAVE treasury management discussions.

This proposal should be known by most of community stakeholders because of all the changes it implicates. I can’t argue more with @oaksprout on the need to make it more accessible with different levels of details.

Hey @jose_delphi!

Thanks for taking the time to reply with a fantastic and well thought-out response. However, I’d like to continue the conversation. Let me preface this by saying that I may not be understanding everything here up to your (& the folks at Delphi Digital’s) level.

I’m just a regular participant, looking to understand the intricacies of your proposal and the long-term implications of such a system. Alright, with that said, here are more questions!

Correct me if I’m wrong, but imagine Aave has 10 hypothetical aDAOs and each is earning the same exact amount of fees in total (bear with me here…). Let’s dub that amount “N.”

So, in a scenario like this, each aDAO staking module would earn 0.8N in fees, whereas the ecosystem reserve would earn 10 * 0.2 * N = 2N in fees.

Although this doesn’t mean the yield will be greater, it does mean that with each additional aDAO, the yield will momentarily increase, hypothetically causing an influx of AAVE capital from aDAO security modules to the ecosystem reserve in order to balance out the risk/yield ratios.

Assuming this is all true (tell me if it isn’t!), wouldn’t this outflow cause sell/redemption pressure on aDAO tokens, resulting in a situation where active aDAOs are incentivized to fight against any new aDAOs in order to prevent their token from facing inevitable downward price pressure?

Expanding on that, the yield would increase in that particular safety module as liquidity flows back into the nearly risk-less ecosystem reserve. Which, under normal circumstances would be a welcome improvement to current stakers! However, since the staked AAVE their aDAO tokens are entitled to is variable with regards to the bonding curve aDAO token price, they may lose out on value despite the yield increase. Am I understanding this right?

More on this later when I talk about the bonding curve again…

Under this system, the only place stablecoins would be able to be borrowed would be the main Aave market- I disagree with giving aDAOs exclusive licenses over assets at all, because I believe it causes a significant reduction in utility. Even right now, the Uni-V1 liquidity token market has access to stablecoins in their own market.

In the current system, common assets/currencies (especially stablecoins) are going to be split between different markets… And this is a-okay since it isn’t a zero-sum situation; nobody really loses out. (Bar maybe people that need an unreasonably huge flash loan on very rare occasions…)

Implementing aDAOs would require, as far as I understand, either the implied reduction in utility caused by granting asset-exclusivity, or, if assets are allowed in any aDAO, a reduction in fees earned, and likely downward sell pressure on other, already implemented aDAOs.

I think I explained that pretty badly, let me try giving an example:

Picture a situation where two traders want to borrow DAI. One would like to use their RealT tokenized mortgage note as collateral, and the other wants to use YFI.

If both of those assets are in different markets, (as they likely should be), under the current system, I think this works fine.

In an aDAO system with asset-exclusivity, only the YFI borrower would have access to DAI since DAI is an asset exclusive to one market, in this case assumed to be the main Aave market. This is a reduction in utility.

In an aDAO system without asset-exclusivity, this works fine for both users- the problem lies in the aDAO token pricing. Jump back in time for a second and picture a staker in the main Aave aDAO, before the real-world asset money market aDAO was implemented…

Because of the bonding curve mechanism, the staker knows that they would lose yield AND Aave-denominated aDAO token value should the real-world money market aDAO come to fruition, since it would cause an outflow of common currencies (in this example, DAI) to the other aDAO. This would cause a reduction in yield, which in turn would cause an outflow of AAVE from that security module- the staker risks not only earning less yield, but losing some of the AAVE they originally deposited. Does that make sense?

I hope that sort of clears up my concern. Let me know if it doesn’t!

This is interesting because in the proposal, a new aDAO would require a minimum threshold of AAVE pre-staked in order to come into existence. Doesn’t that bootstrap safety module liquidity?

Furthermore, wouldn’t early staking be rewarded by a higher yield as more fees are distributed to less staked AAVE? On top of that, if I understand correctly; the idea is to reward early believers in the aDAO through positive price pressure as more AAVE gets staked, and thus aDAO tokens bought, right?

If that’s the case, isn’t this a double-edged sword because it inherently means you’re punishing later stakers?

E.g: If an early staker decides to sell his aDAO tokens for more AAVE than he originally staked (due to the increase in total staked AAVE), he’s profiting from other participants in the aDAO. I don’t think this is especially healthy or necessary.

I can’t help but think that having pure AAVE staked, without an intermediary bonding curve aDAO token, would remove both complexity and risk from the system. Although that’s just from what I understand.

I’m definitely not against implementing a system that requires an initial stake to bootstrap new market insurance, and letting the market’s yield balance out the staked AAVE in its given security module from there, if that makes sense.

Interesting point here, I definitely get it now! However, since Aave (and DeFi in general) are open-source, I’m worried about the impact being under the “brand” will really have, when anyone can deploy the same, exact and verifiable systems without having to go through losing n% (in the proposal, 20%) of fees.

In fact, they might even be able to reduce fees compared to the regular protocol while maintaining higher effective %fees going to their safety module. This, in my eyes, would potentially pose a threat. Liquidity chases secure yield, and borrowers chase low fees, after all!

I like where the conversation is going! However, I’m not sure about this. In an ideal situation, every token holder would research their protocol, understand governance and delegate wisely. But- we’re not in an ideal world. Still, I do believe that a significant portion of the community would indeed be involved in governance, or at least delegate effectively. As you said, it’s not the focus of the proposal, but a neat conversation nonetheless.

I totally agree here. I’m still iffy on the whole aDAO situation (and to be honest, I’m not even sure we should implement an origination fee at all. I’m currently more in favor of redirecting a portion of depositor interest to the reserve(s)/stakers), but I am seriously leaning towards segregating insurance risk between different markets.

This is a fantastic discussion, and exactly what DeFi should be all about.

Thanks again @jose_delphi!

Edit* Typo

1 Like

Appreciate all the great questions and will get to them now. In the meantime, a few of you asked for it so we decided to put together a video walkthrough version of the proposal which you can find here: https://www.delphidigital.io/reports/aave-proposal-walkthrough/

We hope this format makes it more digestible for the community and allows more people to engage with the content. As always, we’d love to hear the community’s feedback on this!

3 Likes

@jose_delphi In general I think, this is an interesting idea. What I miss in the discussion until now is the security aspect. By this design you increase the code complexity. This means potentially more bugs and an increased attacking surface.

What this means, you can see at bzx. They were already hacked twice. The main reason was, that they increased the code complexity by adding a trading functionality.

5 Likes

Good catch.

@gyoung, appreciate the kind words and the support. Will answer your questions in turn:

  • This is a great point. We’ve considered those kinds of mechanisms but ultimately we need to do some modeling to figure out what’s appropriate. All I would say here is that the aDAOs, similar to Aave itself, are more like startups than established banks/lending facilities. As such, the majority of cashflows are expected to come in the more distant future such that the yield in the short to medium term is more likely to be captured via $aDAO token appreciation as a result of increased traction vs actual fee yields.
  • This is another great point. We actually feel your specific example wouldn’t be too much of an issue since the aDAO mandates should be sufficiently differentiated and the risk framework well-defined enough that it should be clear where assets should sit. That said, a related edge case is where an aDAO initially has mandate over a risky asset which as time goes on becomes less risky such that it more appropriately fits into another aDAO’s mandate . This is also likely to coincide with that asset generating more fees which makes it problematic for the first aDAO which took the risk and is missing out on the upside.

There are solutions to this such as explicitly granting an aDAO a “license” over a certain asset for X time period to at least allow them to capture the upside for a fixed amount of time, after which it becomes an $stkAAVE holder decision where the asset should sit. Ultimately, we believe these protocol-wide decisions should be made by $stkAAVE holders in a way that benefits the entire ecosystem.

  • Agreed. Realistically, most aDAOs will initially be started either by Aave itself or by experienced members of the community who also have the most to gain in being early to a successful aDAO. Over time, this is where we see reputation playing an important role in helping to appropriately reward users who make value-add contributions over passive capital providers
  • This is a good idea. We could even build this into the reputation system such that the amount of reputation an individual gains is a function of the fees generated by their proposal. This all has to be carefully thought out and will be a research workstream of its own but this is exactly why we think reputation such an important primitive long-term.

@oaksprout Appreciate the kind words and also the TLDR synthesis you produced on Twitter. It was a great summary and exactly what we need to allow more people to engage with Aave governance. Going through your points in turn:

  • Great question. We did consider quite a few other designs. One of the most promising alternatives was a more traditional tranched model. Rather than segmenting the safety pool, it would instead be split into tranches. Risk-averse users would take the senior tranche which has the lowest risk and upside whereas risk-loving users could take the junior tranches which carry more risk and more upside too. We could then have junior tranche holders have proportionately higher voting power since they effectively have higher skin in the game.

Ultimately, we decided on the aDAO model for a few reasons:
(1) unlike the tranched model, the aDAO model has the potential to make money-market creation permissionless as individuals come together and pool risk to spin up insured money-markets without requiring Aave’s consent
(2) Given fees will likely be kept low as Aave grows, we weren’t sure how a tranching model could work as returns to different tranches would have to be subsidized by Aave and if so, it becomes unclear how to determine the proper price for this
(3) Related to (2), since insurance is currently bundled in with the money-markets products, it becomes difficult to accurately calculate demand, capacity and therefore the price to pay to underwriters

That said, some of the feedback we’ve received on this proposal and further discussions with the Aave team have prompted us to re-evaluate the tranched design. We’re currently researching this and will keep the community posted.

  • Yes. Similarly to Nexus Mutual, withdrawals below the minimum capital requirement are locked.
  • We believe the bonding curve should accept only $AAVE since it forces every $aDAO holder to take on passthrough $AAVE exposure which should in turn encourage them to consider not just their own incentives as $aDAO holders but also the broader ecosystem incentives. Also, an $AAVE holder who wants to support an $aDAO should be able maintain some exposure to $AAVE. This serves to make $AAVE the reserve asset of the ecosystem and will result in more $AAVE being locked as the cashflows of all underlying aDAOs increase.

We definitely don’t think users should have to take on financial exposure to the protocol in order to use it. While initially in some cases the creators of an aDAO may also be its initial users, its important that their role as creator is separate from their role as user and entails some skin in the game in $AAVE for the reasons mentioned above.

  • While I like the concept, I think there’s an incentive problem whenever the people voting on safety parameters aren’t the ones that have to bear the risk of their decisions. In general, we believe those with most skin in the game (i.e. those providing the insurance) should have highest influence on risk parameters. Imo, an alternative way of achieving your goal here is simply to distribute tokens ($aDAO or $AAVE) to holders of pool assets and encourage them to get involved in governance (for instance by mandating that X reputation be earned before they “unlock” their rewards)
  • This is a good idea and something we considered. Ultimately, we feel that, similarly to Aave itself, the aDAOs are fast-growing startups and their valuations will thus mainly be based on cashflows coming very far in the future. In addition, aDAOs may choose to set fees to 0 or even subsidize usage to gain market share and it wouldn’t be optimal for this to depress the $aDAO token price and thus its ability to attract capital. Rather than programatically set a relationship between fees and token price, we would rather set the relationship between price and system capacity and let the market decide what premium they want to pay on top of that.
  • We imagine this being an automated functionality, similar to the one governing liquidations.
  • We feel this should definitely be the goal to strive for but to begin with we would like to keep it more permissioned such that Aave can operate the initial aDAOs itself and we can test out the process/assumptions.
  • Yes sir - really appreciated your tweet and it’s exactly the kind of thing we need to make governance more accessible. I’ve put up a video walkthrough to make this more digestible and we may also have an AMA with the Aave team on the proposal soon. Stay tuned for this :)
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I think will should not constraint the development of new features/designs because it presents a higher risk of attack. Each new line of code is a potential threat.

Nonetheless we need to take the necessary measures to reduce risk :

  • Audits
  • Test period on testnet
  • v1 with one aDAO for a small market, that is not thus covered by Aave safety module
  • v2 with more aDAO
  • v3 totally composed of aDAO

My point is not to constraint the development of new features. I just think, it should be mentioned, that these new features have a price, which is increased security risk. You always should think about, if these new features are worth it.

Sure, audits are a must have, but this isn’t the holy grail. After the first hack bzx made changes, which were audited. Short after going live with these changes, they were hacked again.

2 Likes

Thanks for the thoughtful responses, José!


Tranched Model

I’m curious to read about the tranched model you mention. When we look back at the initial issues you sought to address – reducing contagion risk, expanding risk/reward diversity, boosting innovation – the tranched model does appear to move in that direction, but to a much, much lesser extent. Essentially it would offer 1 or 2 more levels of risk exposure, where the aDAO model could literally provide infinite. Would be curious to hear what feedback led to reconsidering the tranched model. I can see that from an implementation perspective it could offer a more manageable increment in complexity, but I sense you’re not shy about making larger changes to the protocol at such a nascent stage.


External aDAO Control

Funnily enough, this was precisely my concern. If Aave achieves protocol status, then it becomes a massive ecosystem player, whose decisions have major implications on the projects who implement it. Therefore, if external asset holders don’t have a vote on certain parameters, they have to bear the risk of a potentially arbitrary set of actors who don’t hold any skin in their game.

So I remain convinced that for Aave to achieve Protocol status, and the scale which is possible with that status, some element of ownership over aDAOs by the external assets they serve is essential. The simple reason is that Aave and credit in general is such an important component of the ecosystem and to the projects it integrates with, that an aDAO can become a risk to the project in and of itself. Take @Jordan’s recent post about governance attacks. Governance attacks don’t directly hamper Aave – they adversely affect the projects that implement Aave. You mention skin in the game, but the reality is that having skin in the Aave game is only one part of the problem – for implementing projects to trust aDAOs they need to feel like they have some control, too.

You mention the risk of using external assets to govern risk parameters that have potential to adversely affect Aave itself – to be clear, I’m not prescribing that. Concretely, the kind of parameters I suggest external asset holders can vote on are those that directly affect risk or functionality of external projects. For example, I suggested a binary option to allow external asset holders to vote on whether their pool issued a ‘marked’ token – a bToken – which could prevent governance attacks. Whether or not that idea has legs aside, it’s the kind of optionality which would inarguably make Aave a more desirable option for go-to credit protocol.

I recognise the idea of allocating aDAO tokens to external holders, but I must admit that feels like heavier work than simply using the assets themselves as aDAO governance tokens. Rather I would propose simply making it a parameter, votable on the aDAO – “for parameters X, Y and Z votes will be considered in tokens A, B and C.”


Determinism/Autonomy

Your answers to a couple of my questions around deterministic pricing and permissionless management for aDAOs were essentially “let’s leave it up to subjective consensus”, and I think that does feel sensible. Might be possible to push for greater determinism and autonomy later. :+1:t4:


Upgrades

A separate question which occurred to me – apologies if I’ve missed this in the text – is around what global upgrades would look like. For example, Ecosystem Governance decides that a new parameter is desirable for every aDAO template. How much choice do you imagine aDAOs having in deciding whether or not to upgrade? I’m imagining that if the ecosystem reserve and aDAOs are adequately aligned then the game theory should take of itself over time, but I wondered if you’d had any thoughts.


Enjoyed the video! FWIW I didn’t mean “dense” negatively when talking about the proposal :joy: Just meant very detailed lol.


Cheers!

2 Likes

Thanks @jose_delphi for share the extensive overview of the idea and proposal. After vibrant and active discussion, I want to jump in to comment on few points. Will bullet point my thoughts:

  • Stakers should be able to choose their risk/reward based on their appetite especially as the protocol grows and more markets are introduced
  • New markets might have more risk or even more risk
  • aDAOs are interesting way to slice risk into traches and allow the stakers to choose their risk appetite
  • IMO in current form SM is kind of mutual protocol wide protection, besides slicing the risk based on markets with aDAOs, various risks can be categorized. For example, staking AAVE into SM covers smart contract / technical risk - and staking StkAAVE to aDAOs cover market, liquidity risk etc. Issue here would be the custody for various aDAO1StkAAVE etc tokens for institutions (would require extra work and fragment the tokenization)
  • Easy solution to separate risk in tranches and adjust the rewards accordingly to the risk is to create three risk tranches: Junior, Mezzanine and Senior and adjusting “emission per second” distribution in staking contracts into these three tranches. This would address @Zer0dot’s point on having potential outflows
  • Lower tier (the Junior) can cover either higher risk market or take the higher portion risk of all money markets - this leads to higher rewards on Junior
  • Its important to consider the users, depositor might want to deposit into a more riskier market but also de-risk at the same time. The depositor should have a possibility to also subscribe to better protection of SM/aDAOs even in a riskier market
  • As new markets will become less riskier they can move between tranches as per Aave governance vote
  • The risk tranching should also reward de-risking - via lower Reserve Factor
  • On @Zer0dot liquidity thinning, I think liquidity spreading into various markets is not an issue since this gives an opportunity to build a Vault layer for the end users to choose to deposit between these three risk categories, a re-balancer could be build to move the deposits accordingly with the yields
  • On the reputation and voting, I see it also as interesting feature, would even think that “de-risking and yield score” could be something to consider
  • @gyoung’s point on the fees, we need to consider that the staking rewards would be re-calibrated by the aave governance soon and Aave Protocol v2 would have Reserve Factor that sets aside portion of the interest that can be distributed partly to stakers
  • The competition between aDAOs is something to consider but might not be a negative outcome - might be actually positive especially if the competition leads to reducing risk and optimizations

Tranching risk in general would benefit Aave Protocol, curious to see how this proposal and discussion evolves. Also would want to point out that technical implementation should be simple enough not to introduce substantial amount of complexity and technical risk.

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Thanks for your input @stani!

Risk tranching is definitely an important aspect of Aave’s future development. Could be fascinating to perhaps split the SM into tranches where the junior tranche has a higher maximum slashing % and higher yield, whereas the senior has less yield and lower maximum slashing %.

Just a brain dump, but might be worth discussing.

As for the liquidity thinning aspect, I agree that it’s a non issue in the current model. Although, I believe that under the current proposal, aDAOs would have exclusive custody over their assets, preventing currencies from permeating into different markets.

I’m excited to potentially see this, alongside my previous points of concern, addressed in @jose_delphi’s proposal update!

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There are many interesting ideas here. My main concern is the complexity and game theoretic aspects of the unforeseen market effects between all the potential aDAOs. Either way, until AAVE even reaches a point where this can be practically implemented (partially/fully), there are in my opinion the scaling issues to focus on first. Let’s rather improve the UX which at the moment, and it is not exclusive to AAVE but pertains to DeFi as a whole, sucks from a gas costs POV. They literally eat into yields, that should be dealt with and fairly soon.

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Hey everyone,

We really appreciate all the excellent feedback and comments posted both here and as PM’s. They were extremely helpful in refining our thinking and improving the proposal. We’ve now posted up V2 of this proposal here. You can also read the TLDR tweet thread version here.

We’re excited about the direction this could take Aave and would love to get the community’s feedback!

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