We received some great questions from the community (some of which we paraphrased for brevity). Our feedback is below. Our upcoming Snapshot will present the same options outlined initially above.
We plan on publishing a Snapshot vote on Wednesday, August 31.
- What specific criteria would validate further decreases in these reserve factors? What do you think the timeline looks like for both observing that validation and the subsequent proposal of further decreases?
TVL (supply) of DAI and USDT is where we’d expect to observe the primary impact. Two factors that create noise in the system are market volatility and the behavior of large whales, who can have an outsized impact on TVL. For this reason, we will analyze not just total numbers but also individual accounts to observe behavior after the change.
Next, it is valuable to consider secondary effects on total borrows against the collateral. If the reserve factor decrease does result in increased supply, we expect borrowers to adjust their positions to maintain similar borrow usage as before. We previously observed this behavior in response to collateral factor changes.
Finally, to estimate the impact to the protocol, we will compare the net interest generated for the protocol after the change (reserve factor * borrower interest paid) and compare that to the interest generated the day before the reserve factor change went into effect. If total supplies, borrows, and reserves increase due to the change, we would consider impact as a positive outcome validating that users are elastic to reserve factors. As mentioned before, this will need to be considered in the context of external factors such as market volatility and whale behavior.
Regarding timing, we’ve observed with collateral factor changes that some users react very quickly while others can take weeks to adjust their positions. We recommend waiting for ~one month between subsequent reserve factor changes to observe the effect.
- Why did you choose .025 as the change increment?
The increment was selected based on the scale in statistical analysis. This increment is expected to be large enough to show impact if users are elastic to the change since the relevant stables here have reserve factors that are already low. This represents a 33% decrease for USDT and 17% for DAI. It is prudent to avoid making drastic changes since yield farming is largely an all-or-nothing practice. Once yield farming becomes unprofitable, we’ve observed that users pull their liquidity from a protocol and that liquidity might not return.
- How about increasing one reserve factor and decreasing another?
Changing reserve factors in two different directions, as suggested by @Blockchaincolumbia, creates noise in the data. While the suppliers of each collateral are generally separate profiles, making opposing changes introduces an additional variable where suppliers might flow from one asset to the other. It would be hard to distinguish if the change was due to a change in strategy/risk appetite or to elasticity to the yield impacted by the reserve factors. For this reason, we do not recommend this approach.
- Effective rates are already higher on Compound for LPs than the market due to COMP rewards. Should we raise RFs and incentivize supply with additional COMP instead?
The COMP rewards are indeed what make supplying on Compound more profitable due to their impact on the effective interest rates, but these returns fluctuate with the price of COMP. More importantly, a strategy that relies on incentives in this manner presupposes that those incentives will last forever, a strategy which @sirokko already pointed out is not sustainable, particularly in a bear market. If the goal is to uncover elasticity of users to the real interest rates and reserve factors, then we should not add additional inflation to the interest rates by increasing COMP reward spend.
The behavior currently observed related to USDT borrowing is only profitable due to COMP rewards (and is therefore not sustainable long term). See the following example.
Rates without COMP incentives
| Token | Supply Rate | Borrow Rate |
|---|---|---|
| USDC | 0.73 | 2.14 |
| DAI | 0.72 | 2.22 |
| USDT | 1.39 | 2.96 |
Rates with COMP incentives
| Token | Supply Rate | Borrow Rate |
|---|---|---|
| USDC | 1.15 | 1.01 |
| DAI | 1.23 | 0.90 |
| USDT | 1.52 | 2.71 |
If one were to borrow USDC, convert it to USDT, and resupply it as USDT, they would make around -0.75% interest without COMP incentives and 0.51% interest with COMP incentives, plus however much interest they are making from the original collateral they put down. For instance, if someone were to supply DAI, borrow 83.5% of it (the maximum allowed) as USDC, convert it to USDT, then resupply the USDT, they would make around 0.09% interest without incentives and 1.66% interest with incentives. If we were to decrease reserve factors for USDT, the first order effect would be an increase in supplier interest rate for USDT, which may make this more profitable without additional COMP rewards.
- Should we change the ETH reserve factor?
The challenge with this suggestion is that the ETH merge is upcoming. It would be difficult to attribute observed supply/borrow behavior changes to a reserve factor parameter change with that backdrop.