Interest Rate Curve Adjustment

Proposal to adjust the interest rate curve’s parameters to reduce interest rate volatility

Interest Protocol uses an interest rate curve to dynamically set the borrow and deposit rates as a function of the current reserve ratio (which equals USDC in reserve / USDi total supply). Governance has the power to adjust the parameters of the curve itself to change how each level of reserve ratio is mapped into the borrow rate and the deposit rate.

The current parameters were chosen by GFX Labs prior to launch. Based on our observations of the protocol’s operations for the past two months, we believe that the following parameter adjustments would reduce the volatility of interest rates and improve the usability of the protocol. The interest rate curve is a core component of the protocol and should be continuously improved and thoughtfully experimented with.

Variable Current Value New Value
s1 60% 65%
s2 40% 35%
r1 0.50% 0.50%
r2 10% 20%
r3 600% 300%

Desmos graph

Our rationale for these changes are as follows:

Longer s2-s1
The length of the target range of the reserve ratio, [s2,s1], will increase from 20% to 30%. This is to reduce the likelihood of the reserve ratio diverging from this target range, which results in sharp fluctuations of interest rates.

Lower s2
s2 will decrease from 40% to 35%. GFX Labs set a very conservative s2 at launch, and we believe that reducing the target floor of the reserve ratio to 35% does not pose a significant risk to the USDi peg. By lowering s2, the protocol enables higher utilization of capital that can lower the borrow rate and increase the deposit rate.

Higher r2
r2 will increase from 10% to 20%. We believe the equilibrium nominal borrow rate of USDi may often stay above 10%. This is because the protocol incentivizes borrowers, which decreases the real borrow rate. Raising r2 from 10% to 20% will allow rate discovery to happen across a wider range.

Lower r3
r3 will decrease from 600% to 300%. This will dampen the extreme rate volatility that has been observed when the reserve ratio drops slightly below s2. The maximum rate of 300% should still be punitive enough to drive the market back towards the target range whenever the reserve ratio is below the target floor of s2.


Proposal to adjust the interest rate curve’s parameters to increase capital efficiency.

Given the low prevailing interest rates across DeFi, Interest Protocol would benefit from a more aggressive interest rate curve that allows more lending to occur at lower interest rates.

The proposed curve parameters are shown in the following table.

Variable Current Value New Value
s1 65% 50%
s2 35% 25%
r1 0.50% 0.50%
r2 20% 10%
r3 300% 200%

Desmos graph

Our rationale for these changes are as follows.

Comparison to Proposal 8

Proposal 8, executed on September 9th through an optimistic proposal, decreased s2 from 40% to 35%. The goal of this change was to increase capital efficiency at relatively high interest rates. However, the interest rate on IP has remained low since the execution of Proposal 8. Moreover, Proposal 8 raised s1 (from 60% to 65%). As a result, IP often has a high reserve ratio above 60%, and thus a wide spread between the borrow rate and the deposit rate. This proposal aims to remedy this by lowering the reserve ratio that corresponds to low rates (1-5%).

Lower s1 and s2
The reserve ratios corresponding to the two kinks will decrease, from 65% and 35% to 50% and 25%. This will allow IP to generate more loans at a given rate, increasing capital efficiency and reducing the borrow-deposit spread.

Lower r2
r2, the interest rate corresponding to the reserve ratio s2, will decrease from 20% to 10%. This further increases capital efficiency at lower rates.

Comparison to Compound
The Desmos graph compares the proposed curve to what Compound V2’s interest rate curve for USDC would be if it was directly translated to IP. While the proposed curve is more aggressive than Compound’s at lower borrow rates (below 3.17%), it is significantly more conservative at higher borrow rates (above 3.17%) and therefore continues to provide a strong guarantee of liquidity for USDi redemptions.