Methodology Scope
Our interest rate curve methodology applies only to existing assets with a substantial amount of usage data. For new assets, we can use a default interest rate curve or look at similar assets with live deployments as a reference.
Methodology Objective
The overall goal is to incentivize suppliers to supply liquidity, discourage borrowers from hoarding liquidity, and optimize protocol revenue.
More specifically, the objectives of adjusting individual parameters are:
- Slope 1 — Incentivize more borrowing when utilization is low and more supply when utilization is high
- Optimal Utilization — Set a reasonable buffer against 100% utilization
- Slope 2 — Mitigate 100% utilization and limit the impact on user experience
- Reserve Factor — Trade-off protocol revenue versus supplier interest and recursive borrower profitability
- Base rate — Minimum borrow rate that the protocol is willing to consider
Methodology Summary
We suggest directional changes to IR curve parameters based on heuristics around user elasticity, liquidity concentration, market rates, responsiveness to slope changes, recursive borrowing incentive, token risk, and relative market sizing. Generally, these heuristics include:
- Raise slope 1 if borrowing is overly incentivized
- Lower slope 1 if borrow is overly sensitive to supply
- Raise slope 2 if users are unreactive to excess utilization
- Lower slope 2 if users are overly sensitive to utilization changes around optimal
- Raise the reserve factor if supply is insensitive to borrow
- Raise or lower the reserve factor to adjust stablecoin rates to market comparables
- Lower the reserve factor if recursive borrowing is not profitable near 100% utilization
- Raise slope 2 and lower optimal if whale dominance is high
- Raise slope 2 and lower optimal if supply is large relative to average daily volume or market cap
A more detailed explanation of the methodology can be found here.
Methodology Assumptions
- Users are at least partially elastic to interest rates
- The elasticity of borrowers and suppliers to each other is a reasonable proxy for the elasticity of borrowers and suppliers with respect to interest rates
- Borrower and supplier elasticity does not change very quickly
- Reasonably comparable rates for stablecoins can be found, despite the wide range available in the market
Success Metrics
Interest rate adjustments fall under two categories: risk-on adjustments to generate additional revenue and risk-off adjustments to reduce utilization and risk exposure.
Risk-on adjustments should increase protocol revenue over time, normalizing for external revenue drivers like token price. We periodically assess this revenue impact in retro analysis.
Risk-off adjustments should reduce the time that utilization spends above safe levels. Depending on the asset, changes may have an immediate effect, or it may take until the next high-utilization event for the impact to be observable.
