Background:
When we first launched Alpaca in March of 2021, the market was in a strong bull run.
It was a different environment with high speculative demand and higher yields. BNB Chain yields on DEXes (without leverage) were in the range of 50% - 100% APR for most pools. However, these yields dropped over time as more capital entered the market and farm tokens like CAKE depreciated in price.
Today, all the major farms have yields below 15% APR (as of 29th Mar 2022)
PCS BNB-USDT: 15.01%
PCS BNB-BUSD: 13.94%
MDEX BNB-BUSD: 10.31%
MDEX ETH-USDT: 13.31%
What does this mean for our interest model? The 20% rate in slope2 is too high for the current yield environment and there will be very few borrowers at 20%. It’s just not profitable to do leveraged yield farming at that borrowing rate.
As a result, lending pools’ utilization rarely rises above ~40% (borrowing interest = 15% @ 40% utilization) This was evidenced in the major pools where utilization was hovering between 30% - 40% prior to Automated Vault’s launch.This leaves a lot of unborrowed capital on the sidelines, which also means lower APY for lenders.
We believe a more efficient “equilibrium” could be achieved by lowering the borrowing interest at slope2, which will create higher utilization while still maintaining the same, or even higher revenue, to the lenders.
Example:
| State | Supply (USD) | Borrowed (USD) | Borrowing Interest Rate | Annual Interest paid (USD) | Lenders APR |
|---|---|---|---|---|---|
| State1 | 100 | 30 | 10% | 3 | 3% |
| State2 | 100 | 50 | 9% | 4.5 | 4.5% |
As seen in the simple illustrative example above, with higher utilization, borrowers enjoy lower borrowing interest (10% → 9%) while lenders also earn higher yields (3% → 4.5%)
The question then is: how do we ensure there will be an increase in borrowing demand to increase utilization, compensating for the lower interest rate?
Challenges:
While the core team has discussed this issue internally in the past, the question above is one of the reasons we have not lowered Slope2 borrowing interest until now. There was no guarantee that with a shift in the interest model, there would be a corresponding increase in the borrowing demand.
With no new borrowing demand, lenders and our protocol would end up with less revenue, which could lead to lending deposit withdrawal, potentially creating a vicious cycle where the protocol lost significant TVL.
In fact, we tried with this back in Q3 of 2021 where we moved the Slope2 starting point from 50% utilization to 60% utilization to try to incentivize borrowers to open more positions, but it had no perceptible impact, and we didn’t pursue it further.
Rationale:
With the introduction of Automated Vaults, the situation has changed. We have seen a strong demand from the community for Automated Vaults, with the TVL cap for each 8x pool reached within a few hours of launch.
So with Automated Vaults, we now have high confidence that we could move our system to a higher utilization state where all the participants in the ecosystem will benefit.
Adjusting the interest model would achieve five major benefits:
- Higher APY for lenders
- Lower borrowing interest rate for borrowers
- Higher protocol revenue
- Additional capacity for our Automated Vaults
- Higher lending utilization which provides more platform stability
Proposed Implementation:
We propose the following target interest models for each asset:
Slope2 Kink: utilization at which Slope2 begins
Slope2 Interest: the borrowing interest rate for Slope2 (the flat part)
| Asset | Slope2 kink | Slope2 interest | Lend APYs at Slope2 |
|---|---|---|---|
| BNB | 85% | 12.5% | ~ 10% - 12% |
| BUSD | 85% | 12.5% | ~ 10% - 12% |
| USDT | 85% | 12.5% | ~ 10% - 12% |
| BTC | 85% | 7.5% | ~ 6% - 7% |
| ETH | 85% | 7.5% | ~ 6% - 7% |
| USDC | 85% | 10.0% | ~ 8% - 10% |
As seen above, if we can raise the utilization to Slope2 portion of the model, lenders would also benefit from higher lending APY%
We would not make this implementation in one go, but rather adjust the slope gradually for each token each time we add a new instance of an Automated Vault. This way, we can ensure that lenders and platform revenue will not be adversely affected by a change. The core team will have the discretion to adjust interest models within the boundary above. For example, slope2 kink for BNB will never be beyond 85% and the slope2 interest rate will not be set below 12.5%.
The diagram below illustrates how the interest slope will change. The specific parameters will be based on various parameters at the time - e.g., TVL, APR, etc.
