The Aavengineers have made some sweet improvements to make life better for borrowers, with even more competitive variable and stable rate models.
One of the reasons why Aave has been experiencing such explosive growth is that we are actively collecting feedback from the community and rolling out incremental updates to optimize the user experience. One of the areas where we focused the most is improving the borrowing experience on the platform. Since the beginning, Aave satisfied a lot of demand for stablecoins, and it’s been one of the most competitive lending markets for liquidity providers in the DeFi space.
The reason for this is partially related to the number of collaterals available on the platform: some token holders (LINK, LEND, WBTC, MKR) see Aave as the only entry point in DeFi to be able to leverage their holdings and borrow multiple types of stablecoins. The number of choices in stablecoins is also a distinctive factor, as Aave is the lending protocol with the highest variety (USDC, DAI, USDT, TUSD, SUSD, BUSD). Additionally, the interest rate model that we chose at the beginning, while quite simple and inexpensive to compute, has been working particularly well, balancing good supply APY and enough liquidity available to withdraw at any time with only rare occasions in which users had to wait for a while to be able to withdraw their deposits.
What’s an interest rate model anyway?
Simply put, an interest rate model is the relationship between the liquidity available in the protocol, the borrow demand and the borrow/supply rates. These three parameters are functionally connected so that increasing the borrow demand generates more income for depositors, while at the same time reducing the liquidity available, potentially to the point were users might experience delays in their withdrawals. These conditions, which usually manifest in response to sudden market movements (either increased volatility or external factors not really related to the protocol itself, for example, we are seeing this happening for sUSD because of some structural changes between Curve Finance and Synthetix) are mostly temporary and get compensated with a very high supply APY, to serve the double purpose of attracting more deposits and compensating the depositors for the temporary lack of liquidity. So how does this work on Aave?
The Aave stablecoin model
The following chart represents the current variable borrow rate model for stablecoins. As you can see, the interest rate model is a double slope function that aims for a capital allocation of 80%: it means that the interest rate increases with a relatively small slope until 80% and then raises sharply past 80%. The goal is to reward liquidity providers as the available liquidity drops to near 0, and attract more depositors. With the current interest rate model, DAI and the others stablecoins have a different configuration, with DAI having a slightly steeper slope. However, in Aave we have two interest rate models: variable and stable. How does the stable rate model compare to the variable rate model?
As you can see the current configuration is very conservative for the stable rate. It’s consistently higher than the variable rate to the point that at 80% usage of the capital, the stable rate is more than 2x higher (6% variable vs 13.9% stable). Why? The reason is that the stable rate can be considered a new financial instrument, and as such we started very conservatively with it for two very important reasons:
- We needed to collect data and evaluate how the users use the protocol and what their needs are
- We wanted the liquidity in the protocol to grow to a point where stable rates are more financially convenient: the more liquidity available, the more efficient stable rates are
This conservative approach is reflected in the ratio between the outstanding loans at stable vs. variable rates, where variable rate loans represented a whopping 98% of the total. Still it’s interesting to note that 2% of the users chose the stable rates, even with very high rates to begin with, which means they still preferred predictability even at the cost of paying more. This is set to change now with the new interest rate model that we are releasing today!
What is the stable rate and why do we need it?
The need for more predictable interest rates is as old as finance as we know it. In traditional finance, individuals who borrow at fixed or adjustable rates are users that want to be able to plan their finances in advance, have predictability in their expenses and eventually have the possibility to hedge their investments with more certainty. Many users, especially institutionals, expressed interest in the stable rate borrowing. The feedback we collected highlighted the following:
- Guarantee of stability gives less risk perception, which might incentivize borrowing more
- There is no problem in paying a premium in the interest rates
- Even predefined fixed term durations are acceptable in exchange for stability
In Aave Protocol specifically, the variable borrow rate has a per transaction resolution: it can change, even drastically, with each user interaction (either borrow, deposit, withdraw, repayments or liquidations). Users who borrow at stable rate will be unaffected by these actions. Their rate will remain stable, meaning it will not be affected by user interactions. This is true for all the stable loans in progress, but in fact, the stable rate for new loans varies on each interaction, to better suit the current state of the protocol (liquidity available, depositors APY). However, once the stable loan is taken, borrowers will not experience interest rate volatility. There is one caveat though: if the protocol is in dire need of liquidity (prolonged liquidity shortage, for whatever reason) and the supply APY is not high enough to satisfy the liquidity providers, some stable rate loans might undergo a procedure called rebalancing. If an user’s loan was taken at a stable rate that is too low for the current market conditions, the protocol might decide to move the stable rate to the current (higher) one to provide a more competitive supply rate for depositors. Eventually, as the market situation normalises, the user will be rebalanced back down to a more appropriate stable rate. The current condition to rebalance is the following: a stable rate loan can be rebalanced if the stable borrow APR accrued by the loan is lower than the current supply APY. This is a very conservative condition that might increase the rebalance frequency. Can we do better than this?
A new interest rate model
Starting from today, we applied a new interest rate model for borrow rates to improve the borrowers’ experience:
Three notable differences:
- The optimal point is now up to 90% usage ratio: Although this reduces the liquidity available in the system, it improves capital allocation by 10%, which further increases the APY for depositors while at the same time offering more competitive borrow rates. Given the size of the most liquid stablecoin reserves right now (USDT, USDC, DAI) it will still guarantee 300–400K USD in stablecoins available for withdrawals.
- The variable borrow APR at the optimal point is now at 8% instead of the 6% we had before. This allows us to keep the same APR at 80%, while having a smoother transition up to 90%.
- The stable borrow rate curve is considerably tightened, having the stable rate at 90% usage at only 9.9% (vs. a variable rate of 8%), while it was before 13.9% at 80% usage.
The new interest rate model contract address is 0x247227714bd121c528310e3bbff401ae34c9f9f6. The changes to the contract code are minimal and are mostly related to the configuration parameters. The new interest rate model has been applied to DAI, USDC and USDT, which was not possible to borrow at a stable rate before. Stable rate for the other stablecoins will be enabled as the liquidity available increases.
New rebalance conditions
We identified better rebalance conditions: factually, no rebalances are needed as long as the supply APY past 90% usage is high enough to attract new depositors. The condition to rebalance will be updated as following: no rebalances will be executed as long as the supply APY at 95% usage is above 25%. This will drastically reduce the potential risk of rebalances for stable rate loans. Rebalance conditions will be updated with version 1.0.1 of the protocol in the contracts, but the off-chain strategy to rebalance will already be updated to consider the new rule.
More is coming…
Today’s update marks an important step forward for Aave: after collecting data and evaluating how the protocol is behaving, we now have the chance to keep optimizing it. In terms of revamping the stable rates, our goal is to bring them as close as possible to real fixed rates.
We can’t wait to bring the governance live and to have the community contribute to the process even more. In the meantime, if you have any feedback on how to improve Aave, please join our discord and telegram channels and let us know!