Methodology Scope
Works for all collateral assets, including new listings or existing assets already live on the platform.
Methodology Objective
- Earn revenue for the protocol to compensate for the risk of lending
- Restore a stable price if the stablecoin is not holding parity
Methodology Summary
From a user’s perspective, a Collateralized Debt Position (CDP) protocol is fairly similar to a lending protocol. Both can be used to supply a collateral asset and borrow a stablecoin. We expect users who make trades like this to be sensitive to interest rates. While lending protocols have variable interest rates determined by supply utilization, CDPs have a fixed interest rate in the form of a stability fee. If the stablecoin holds its intended price, we set the stability fee based on comparable rates for the same collateral on other lending platforms. Setting the stability fee on par with similar on-chain lending rates generates value for the protocol without making loans too expensive for users. If the asset is listed on the largest lending platforms, we set the stability fee based on the following formula:
For the Stablecoin Borrow APY we use the lowest rate among popular stablecoins, assuming that users view them as interchangeable. If the asset is not listed on major lending platforms, we can use data from similar assets or simply assume an Asset Supply APY of 0% as a conservative starting point.
When a CDP stablecoin trades consistently below parity, emergency measures need to be put in place. In this scenario, we want users to buy back the stablecoin to repay their loans. Users already have an incentive to do this, as loans can be more cheaply paid off when the stablecoin price drops. If the price incentive is insufficient, the stability fee can be gradually raised above what the formula implies until the stablecoin returns to parity. This should happen in conjunction with other policies, such as a freeze on all risk-on parameter changes.
If the CDP stablecoin trades consistently above parity, we can lower the stability fee below the value from the above formula to encourage more borrowing.
Methodology Assumptions
- Markets for collateralized stablecoin borrowing are highly competitive
- Interest rates on major lending platforms are representative of the market price for on-chain loans
- Users are chain-agnostic (for protocols outside Ethereum mainnet)
- Users view debt denominated in different stablecoins as interchangeable
Success Metrics
- The protocol experiences healthy growth
- The stablecoin maintains its intended price
- Protocol annual revenue (including but not limited to stability fees) exceeds both actual insolvencies and value-at-risk
