In November 2022, Gauntlet launched interest rate optimization as a new feature of our risk management product. Since then, we have been recommending interest rate adjustments to our risk clients, with the goals of mitigating risk and building protocol reserves. This article reviews the adjustments we proposed for Venus in Q1 2023 and the significant impact they produced. Our analysis builds on earlier work by Messari, who observed the impact of interest rate changes in their Q1 Venus report. We conclude that interest rate optimization for BNB on Venus generated the majority of Q1 net revenue and over $2M of additional reserves as of May 2023.
Mitigating Risk
The primary goal of interest rate optimization is managing risks stemming from asset utilization. High utilization can restrict suppliers ability to withdraw assets from a lending pool. For example, if a pool contains 10M USDT, and 9M USDT are loaned out, suppliers can only withdraw a maximum of 1M USDT before exhausting the available supply. This can also hinder liquidations because, at 100% utilization, only supplier tokens (i.e. not the underlying collateral) can be seized. If liquidators are unwilling to seize positions without immediate collateral available, the protocol risks creating insolvent debt. Interest rates can mitigate utilization risk by incentivizing borrowers to repay their loans and suppliers to increase supply. Both of these effects would decrease utilization and mitigate risk.
Building Reserves
The second goal of interest rate optimization is capturing income to build protocol reserves. Since lending profitability depends on market conditions, this goal is more opportunistic in nature. Reserves serve as the rainy day fund for protocols and over time may also be used to fund operations, reducing the reliance on native token treasuries. Interest rates can be used to harvest increased reserves when specific conditions arise. Since reserve growth is directly proportional to total borrows, the borrow rate, and the reserve factor, opportunities to build reserves can occur when:
- Total borrows rise due to predictable factors
- Borrowers are insensitive to increased borrow rates
- Suppliers are insensitive to increased reserve factors
Impact
Throughout our work with Venus, we have observed that borrowing of BNB tends to spike around the time of Binance Launchpad events. Since Binance incentivizes BNB holdings during these events, borrowers are relatively insensitive to higher interest rates. This predictable effect increases borrows substantially and may create high-utilization risks if not managed accordingly.
In March 2023, we proposed a set of interest rate changes for Venus that included adjustments to the BNB interest rate model. Though utilization was low at the time, we expected it to rise in the future and recommended increasing borrow rates and reserve factors as shown below. Through this change, we aimed to reduce the risk of utilization reaching 100% and build Venus reserves during future utilization spikes.
Shortly after the proposal was implemented, Binance held a Launchpad event lasting about 5 days. As noted by Messari, this period generated the majority of the $1.1M protocol net revenue earned by Venus in Q1. Without the interest rate adjustment, revenue would have been substantially lower. Since the end of Q1, there have been two additional Launchpad events that sharply drove up utilization. We estimated the difference in protocol interest generated with and without the changes across these events, which is shown in the chart below. In total, we estimate that the interest rate adjustment for BNB has contributed an additional $2M to Venus reserves as of May 2023.
From a risk management perspective, we noted that utilization still briefly approached 100% during two of the three Launchpad events. As a follow-up, we proposed a slight additional increase of BNB interest rates at high utilization, which was executed on June 1. In future utilization spikes, we will monitor how the latest update performs and propose further changes if needed. The impact of interest rate adjustments on both risk and revenue highlights the importance of careful analysis and optimization. We are encouraged by the significant results for Venus and will continue to seek opportunities to adjust interest rates for the benefit of protocols we serve.
