Simple Summary
Recommendations
Gauntlet recommends the following changes to the Ethereum v3 USDC IR curve:
- Increase Annual Supply Interest Rate Slope Low from 0.0325 to 0.034
- Increase Supply Kink from 80% to 95%
- Increase Annual Supply Interest Rate Slope High from 0.4 to 0.76
- Decrease Annual Borrow Interest Rate Base from 0.015 to 0.01
- Decrease Annual Borrow Interest Rate Slope Low from 0.035 to 0.0333
- Increase Borrow Kink from 80% to 90%
- Decrease Annual Borrow Interest Rate Slope High from 0.25 to 0
Current vs Proposed IR Curves
Utilization vs APRs
Utilization vs Daily USDC Reserve Growth (holding current $185M USDC borrows fixed)
Currently the protocol is facing the following problems:
- Stagnant protocol growth/migration and poor borrower UX
- Negative net protocol profit (USDC reserve growth - COMP distributions)
The proposed IR curve attempts to solve these problems as follows:
- Flatline Borrow APR past the borrow kink
- Adjust borrow/supply kinks & slopes to incentivize efficient and appealing equilibrium APRs
Analysis
Problem 1: Stagnant protocol growth/migration and poor borrower UX
As seen in the above chart, USDC borrows in Ethereum v3 USDC stagnated around $220M from 4/27/23 to 5/11/23, and decreased to $185M by 5/15/23.
The current IR curve is shown above. The borrow kink occurs at 80% utilization, which corresponds to 4.3% Borrow APR. The slope of the borrow interest rate to the right of the kink is 0.25, which results in borrow APR rapidly increasing at >80% utilization.
The most recent proposal to increase COMP rewards for USDC borrowers was executed on 4/5/23, when equilibrium was roughly 66% utilization. A large borrower then joined the protocol on 4/14/23 to take partial advantage of the rewards, increasing utilization to 80%. However, as indicated above, borrowers are empirically unwilling to borrow substantially past the 80% utilization kink. This causes stagnation and prevents the protocol from utilizing the remaining 20% (~$50M) of borrowable USDC.
Borrowers are so averse to borrowing past the kink that even appealing Net Borrow APRs do not incentivize them to do so.
During the rare times when a borrower does decide to borrow slightly above the kink, borrow APR increases for all the other borrowers in the protocol, at times over 6%. This results in higher Average Borrow APR and poor borrower UX.
On 5/11/23, a USDC borrower increased their borrow position, thereby increasing utilization to 86% (5.8% Borrow APR). Shortly after, a different borrower with address 0x0cc5a715b06c8ece9f2fa49cdc75750539255779, who previously borrowed $15.2M USDC, completely closed their borrow position, and in fact switched to supplying $3.5M USDC. Therefore, this high variable borrow APR above the kink can result in borrowers closing their positions, despite appealing Net Borrow APR.
Problem 2: Negative net protocol profit (USDC reserve growth - COMP distributions)
The above chart shows Daily Net Protocol Profit at different utilization levels under the current IR curve, holding the current $185M USDC borrows fixed. Even at the current most efficient utilization level of 80%, the protocol accumulates $5,320 of Daily USDC Reserve Growth, loses $16,850 of daily COMP rewards, for a best-case Net Daily Protocol Profit of -$11,530, which essentially results in the protocol swapping COMP for USDC at 68% slippage at best.
Above is an hourly time series since 3/1/23 of realized USDC reserve growth relative to COMP distributions. As we see, the protocol sometimes effectively swaps COMP for USDC at 100%+ slippage.
As seen above, since 3/1/23, the protocol has accumulated ~$200k USDC reserves, lost ~$1.2M COMP rewards, for a Net Protocol Profit of -$1M, essentially swapping COMP for USDC at ~83% slippage on average.
Therefore, Compound could improve their allocation of COMP rewards relative to the TVL and IR curves.
Solutions
Proposed IR Curve Feature 1: Flatline Borrow APR past the borrow kink
Setting a max Borrow APR even at high utilizations results in borrowers always being incentivized to join the protocol, regardless of utilization. This avoids stagnation and improves efficiency, allowing borrowers to takefull advantage of all the borrowable USDC and the appealing Net Borrow APR.
This change also gives borrowers long-term peace of mind knowing their max rate is capped regardless of utilization fluctuations, thereby improving UX, reducing existing borrower outflow, and further incentivizing borrowers to join.
As seen in the above chart, USDC suppliers quickly join the protocol when supply APRs spike above 5%. Therefore, under the proposed IR curve, even though the protocol would incur short-term losses at high utilizations due to high supply APR and low borrow APR, equilibrium should reestablish quickly, and the greater long-term reserve growth should outweigh the short-term losses.
Also, the long-term reserve growth as a result of greater borrows would mitigate and possibly entirely overtake the relative COMP distribution losses, thereby resulting in positive Net Protocol Profit.
Proposed IR Curve Feature 2: Adjust borrow/supply kinks & slopes to incentivize efficient and appealing equilibrium APRs
With borrowers now incentivized to borrow past the borrow kink, the protocol can increase its intended equilibrium utilization range to offer more appealing supply and borrow APRs, thereby further incentivizing both suppliers and borrowers to join the protocol.
The largest single-user v3 USDC borrower borrows $27M USDC. Given the current USDC supply of $266M, 90% utilization would still result in ~$27M borrowable USDC. And borrowable USDC will only increase as TVL increases. So an intended 85-95% utilization range is reasonable.
Therefore we should ensure:
- USDC borrowers are more incentivized than suppliers to join the protocol at ≤ 85% utilization
- Both USDC suppliers and borrowers are incentivized to join the protocol at 90% utilization
- USDC suppliers are more incentivized than borrowers to join the protocol at ≥ 95% utilization
- The IR curve yields highest positive reserve growth between 85%-95% utilization
To determine which APRs to set at these benchmark utilizations, we should first analyze empirical behavior of suppliers and borrowers at various historical utilizations and APRs.
Note that Borrow APR is not equivalent to Net Borrow APR due to the varying COMP borrow distributions, and borrowers have empirically been unwilling to borrow past the kink. On the other hand, the protocol has never allocated COMP distributions to USDC suppliers, and a supply kink still remains in the proposed IR curve.
Therefore it’s difficult to speculate on exactly how much more/less borrowers will be incentivized vs suppliers under the new IR curve, and it will most likely require refinement in future proposals after analyzing how users respond to this change.
Supply APR Analysis
USDC supply in the protocol has consistently increased since the USDC depeg on 3/11/23, even when USDC supply APRs were as low as 2.1%. Interestingly enough, the rate of USDC supply has decreased of late despite higher supply APRs. The Average Supply APR since 3/1/23 is 2.55%. As mentioned before, suppliers are quick to join the protocol when supply APR spikes above 5%.
Borrow APR Analysis
In the few weeks prior to the most recent COMP distribution migration on 4/5/23, utilization was roughly around 66%, corresponding to a Borrow APR around 3.8%. After the migration, utilization increased to 80% and has since fluctuated slightly above and below the 80% kink (corresponding to 4.3% borrow APR), with borrows stagnating and regressing due to reluctance of increasing borrows above the kink. The Average Borrow APR since 3/1/23 is 4.13%, and the Average Net Borrow APR since 3/1/23 is 0.34%.
Proposed IR Curve
The proposed IR curve is shown above.
| Utilization | Supply APR | Borrow APR | USDC Reserve Growth |
|---|---|---|---|
| 80% | 2.72% | 3.66% | 7.21% |
| 85% | 2.89% | 3.83% | 11.24% |
| 90% (borrow kink) | 3.06% | 4.00% | 14.94% |
| 95% (supply kink) | 3.23% | 4.00% | 14.94% |
| 100% | 7.03% | 4.00% | -75.88% |
As shown in the above table, the proposed IR curve ensures the following:
- USDC reserve growth is positive within the desired 85%-95% equilibrium range
- USDC borrowers are incentivized to take full advantage of all borrowable USDC
- USDC suppliers are greatly incentivized at ≥ 95% utilization to join the protocol and decrease utilization back down to a level of positive USDC reserve growth
Additionally, compared to the realized 2.55% Average Supply APR and 4.13% Average Borrow APR since 3/1/23, the proposed IR curve offers more appealing APRs for both suppliers and borrowers at the intended utilizations, thereby incentivizing protocol growth.
The proposed Borrow APRs are also set to levels which should still be appealing to users even if COMP borrow distributions are diluted or reduced, which allows the protocol optionality in the future to reduce COMP emissions/losses without greatly affecting borrower UX, and eventually achieve positive Net Protocol Profit.
The specific changes required to create this proposed IR curve are:
- Increase Annual Supply Interest Rate Slope Low from 0.0325 to 0.034
- Increase Supply Kink from 80% to 95%
- Increase Annual Supply Interest Rate Slope High from 0.4 to 0.76
- Decrease Annual Borrow Interest Rate Base from 0.015 to 0.01
- Decrease Annual Borrow Interest Rate Slope Low from 0.035 to 0.0333
- Increase Borrow Kink from 80% to 90%
- Decrease Annual Borrow Interest Rate Slope High from 0.25 to 0
Potential risks of the proposed IR curve
Greater USDC reserve losses at ≤ 72% utilization and ≥ 98% utilization
Above is a comparison of Utilization vs Daily Reserve Growth between the current and proposed IR curves, holding the current $185M USDC borrows fixed. The proposed IR curve has greater USDC reserve losses at ≤ 72% and ≥ 98% utilizations. However, as seen below, these losses are still minimal relative to the daily losses in COMP distributions.
Limited USDC supplier withdrawals at high utilizations
The proposed IR curve incentivizes higher equilibrium utilization and can incentivize large borrowers to max out utilization at 100%. Existing USDC suppliers should theoretically be incentivized to remain in the protocol at higher utilizations and corresponding higher supply APRs. Existing and new USDC suppliers should be also be incentivized to increase supply to the protocol to free up USDC liquidity. However, USDC suppliers for whatever reason may still want to withdraw their supply at high utilizations, but would be limited or restricted from doing so, which would result in poor supplier UX.
Additional Recommendations (if possible)
- Add a USDC supply cap and dynamically set it to an amount which results in 72% utilization, to avoid excess USDC supply and negative reserve growth.
- Transfer $10M v2 USDC reserves to Ethereum v3 USDC. If the protocol experiences sustained utilization of 100% for 24 hours with no new suppliers entering the protocol (despite high supply APR enticing new suppliers to join), allocate $5M reserves to USDC supply to decrease utilization, which will decrease reserve losses and increase borrowable USDC. Adjusting desired utilization dynamically via reserves is much quicker, direct, and stable than adjusting COMP distributions, which are sensitive to TVL & COMP price fluctuations.
Next Steps
- Targeting on-chain vote on 5/22/23
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