Thanks, @monet-supply, for the thoughtful proposal. Here we provide Gauntlet’s analysis of the impact of the proposed changes under different scenarios.
Given that a user can potentially benefit from the forked PoW ETH (ETHW) by borrowing ETH before the merge, we formulate a rational user’s decision logic as follows:
A user will borrow ETH if the expected ETHW value exceeds the ETH borrowing interest and the transaction cost (price slippage for selling ETHW on a centralized exchange, gas fee).
The proposal updates the interest rate model to a jump rate model, accelerating the interest rate if the pool utilization exceeds the Kink. As seen from the above formula, the efficacy of the interest rate change also depends on the expected yield of fork farming (expected ETHW price / ETH price) and the duration of ETH borrowing (time between borrowing ETH and selling ETHW to USD on a centralized exchange).
As pointed out by @allthecolors, the effect of the PoW fork is similar to the effect of a positive Ampleforth rebase, where both create profit opportunities at a scheduled time. We conducted a similar analysis of the relationship between AMPL rebase and AMPL interest rate. Similar to the positive AMPL rebase, if ETHW retains non-negligible value, raising the interest rate cannot completely eliminate 100% pool utilization since the borrow duration can be short (within minutes). Even if the maximum borrow rate is 1000%, a daily borrowing cost of 0.66% is negligible if a user only borrows ETH for a few minutes. However, raising the interest rate can make ETHW fork farming less profitable, reducing the time of 100% utilization. The downside is that raising interest rates makes the market more unpredictable when the ETH pool utilization exceeds the Kink.
If the community’s goal is minimizing ETH illiquidity, it’s more effective to set a low borrow cap (like what @monet-supply suggested), and the community multi-sig can update the borrow cap when the Kink is lower than it, since
- The acceleration of borrowing cost will not kick in if the borrow cap is less than Kink.
- Predicting the value of ETHW and the amount of ETH supply on Compound around the Merge is difficult.
- Increasing interest rate won’t completely eliminate 100% pool utilization if ETHW retains non-negligible value.
- Increasing interest rate makes the market more unpredictable when the ETH utilization is above Kink.
- The governance process for updating interest rates is slow.
Conclusion
We support upgrading ETH’s interest rate model, but increasing ETH’s interest rate at 100% utilization doesn’t completely solve the ETH utilization problem. We support setting a borrow cap for the cETH market of 100,000 ETH, per Monet Supply’s suggestion.