Review of Gauntlet’s BASE Recommendations (2024-02-28)
Warden has reviewed Gauntlet’s proposal and recommends applying the proposed changes. Furthermore, given the recent increase in WELL price, Warden will proceed with reducing supply-side rewards for DAI to help mitigate risks associated with low on-chain liquidity environment for the asset.
Key observations
Warden has analyzed changes in market conditions over the last month which may have an impact on risk and growth of Moonwell Base protocol.
Source: Search Markets | Warden Finance - Risk & Analytics for DeFi
1) Critically low DAI circulating supply
DAI circulating supply on Base is critically low vs. total market supply. In order to mitigate risks of accumulating bad debt when liquidating large collateral positions, we generally recommend lending market supply to be capped to a maximum of 50% of on-chain circulating supply. In the case of DAI, total supply on Moonwell’s market is currently standing at 110% of circulating supply.
2) Low rETH circulating supply
rETH circulating supply (900) is a limiting factor for growth of the lending market.
3) Suboptimal utilization for rETH and cbETH markets
Utilization for USDC, DAI, WETH and wstETH is currently at optimal levels (equal or slightly below kink). However, rETH and cbETH lending pools have been fairly underutilized over the past few months.
4) Healthy on-chain liquidity for USDC, cbETH, wstETH
On-chain liquidity for USDC, cbETH and wstETH currently allow for further growth to be sustained for the lending markets with marginal increase in risk for the protocol to accumulate bad debt.
Analysis
Warden has reviewed Gauntlet’s recommendations and is in favor of applying the proposed changes. Furthermore, Warden proposes reducing supply-side DAI rewards to help mitigate liquidity and concentration risk for the market.
LST markets reserve factor increases
Gauntlet recommends increasing reserve factor for LST lending markets using the following parameters.
| Risk Parameter | Current Value | Recommended Value |
|---|---|---|
| wstETH Reserve Factor | 25% | 30% |
| rETH Reserve Factor | 25% | 30% |
| cbETH Reserve Factor | 25% | 30% |
Given that demand for borrowing LSTs is generally not very elastic to interest rate, increasing the reserve factor may have net positive impact on ability to accrue reserves for the protocol while having little to no negative impact on borrowing demand on these markets.
We are generally in favor of this change, as it has a high probability of yielding net positive impact for the protocol and may be easily reverted if not.
Mitigating DAI concentration and liquidity risk
Given degrading on-chain liquidity for DAI on Base and very high concentration on Moonwell lending market, we maintain our recommendation to apply preventive measures which aim to reduce risk for the protocol to accumulate bad debt due exposure to DAI concentration and low liquidity.
In order to mitigate risks associated with high concentration and low liquidity, Gauntlet proposes:
- Increase reserve factor
- Decrease supply and borrow caps
- Adapting the IR model to mitigate liquidity risk for lenders
In addition to 1), 2) and 3), Warden recommends to reduce supply-side rewards for the market.
Reserve factor
| Risk Parameter | Current Value | Recommended Value |
|---|---|---|
| DAI Reserve factor | 0.15 | 0.2 |
Firstly, Gauntlet recommends increasing DAI market reserve factor from 15% to 20%. Warden generally recommends adjusting reserve factors in accordance with the risk profile of individual markets. Given the recent increase in concentration risk, we support the proposed change. Increasing the reserve factor will help grow protocol reserves and slightly reduce borrowing demand for the market.
Supply / borrow caps
| Risk Parameter | Current Value | Recommended Value |
|---|---|---|
| DAI Supply Cap | 4,500,000 | 2,500,000 |
| DAI Borrow Cap | 3,800,000 | 2,000,000 |
It is our assessement that proposed caps will be very effective at limiting supply and borrow demand, as they are exactly in line with current total supply and total borrow.
IR model
| DAI IR Parameters | Current | Recommended |
|---|---|---|
| Base | 0 | 0 |
| Kink | 0.8 | 0.75 |
| Multiplier | 0.05 | 0.067 |
| Jump Multiplier | 8.6 | 9.0 |
Current APRs
| Utilization | Borrow APR | Supply APR |
|---|---|---|
| 0% | 0% | 0% |
| 80% | 3.99% | 2.71% |
| 100% | 175.99% | 149.59% |
Projected APRs
| Utilization | Borrow APR | Supply APR |
|---|---|---|
| 0% | 0% | 0% |
| 75% | 5.02% | 3.01% |
| 100% | 230.02% | 184.02% |
The proposed IRM change by Gauntlet is appropriate to provide more leeway for large positions to pull out of the market as we aim to decrease overall market utilization. Increasing the max borrow rate from 176% to 230% also decreases liquidity risk for lenders.
Supply-side rewards
Lastly, the recent price increase in WELL has increased the net supply-side rate to very attractive levels for lenders, which . Recursive lending strategy using max leverage on DAI market currently yields 42.87% APY. Given this observation, Warden may decrease supply-side rewards on the DAI market in order to reduce demand for lending and borrowing on the market, which should help reduce DAI circulating supply concentration on Moonwell.
Source: Warden Finance
Scaling caps with growing demand for lending and borrowing
Proposed supply and borrow caps by Gauntlet for wETH, rETH, wstETH and USDC are all in line with demand and do not significantly increase the risk for the protocol to accumulate bad debt.
We also note that the proposed supply cap for rETH is at the upper limit of Warden’s recommended cap limit (~75% of circulating supply).
| Risk Parameter | Current Value | Recommended Value |
|---|---|---|
| wETH Supply Cap | 10,500 | 12,500 |
| wETH Borrow Cap | 8000 | 10,500 |
| rETH Supply Cap | 600 | 700 |
| wstETH Supply Cap | 1600 | 1800 |
| wstETH Borrow Cap | 700 | 800 |
| USDC Borrow Cap | 10,000,000 | 12,000,000 |
WETH liquidity profile
Source: Warden Finance
Native USDC liquidity profile
Source: https://www.warden.finance/tokens/USDC?chain=8453
wstETH liquidity profile
Source: https://www.warden.finance/tokens/wstETH?chain=8453
rETH liquidity profile
Source: Warden Finance
Next steps
- Reduce DAI supply-side rewards to help decrease lending and borrowing demand which will reduce risks associated with low liquidity and concentration. Rewards may be re-allocated to WETH to promote leveraged LST strategies, which generally has net positive impact for the protocol.