Idea: Fei Protocol Target Rate

Ideas
1

Idea: Fei Protocol Target Rate

Author: Cozeno

Summary:

Formally adopt and publish monthly a quantitative benchmark target interest rate. Monetary policies and lending deployments can be created in the future to achieve this interest rate.

Rationale:

An fairly early goal of Fei’s lending deployments has been to provide a consistent, low interest rate to borrowers; which would in turn incentivize the usage of the stablecoin itself.

In the operation of Optimistic Approval, and in the history of FEI’s lending deployments itself, FEI’s realized interest rates have fluctuated wildly on Rari pool 8, Aave and other platforms. The OA has been by and large unable to deal with short term rate fluctuations since it is handicapped by the lack of FIP mandates and operational guidelines.

Many users have voiced concern in discord about the instability of interest rates. Stable interest rates are a top policy goal for nearly all operators of monetary policy worldwide and given that many of the initial motivations of suppressing FEI’s borrowing rates have not changed. It would be prudent to create a target interest rate which will guide future deployment and minting of FEI.

With the merger of FEI and Rari, Fei Protocol’s ability to influence its own borrowing market has substantially increased. Thus

If approved in principle, the author will elaborate follow up proposals which will seek to authorize minting and deployment of new FEI on a dynamic basis to bring the prevailing borrowing rates of FEI across different platforms to match that of the FPTR.

Methodology:

The proposed Fei Protocol Target Borrowing Rate will be a weighted average benchmarked initially composed as follows: (The following numbers are for illustrative purposes only, authoritative figures will be published pending further discussion and finalized by the time of a potential DAO vote)

In the initial proposal, the author proposes that this target interest rate be updated once every month. This predetermined date (potentially the first of every month) where the new FPTR is published will be known as “Benchmark Date”.

Weight Figure (Feb 3 2022) Weighted value
Aave USDC rate (30 days avg) 10% 3.56 0.356
Aave USDT rate (30 days avg) 10% 3.81 0.381
Aave DAI rate (30 days avg) 10% 3.85 0.385
COMP USDC rate (30 days avg) 7% 4.09 0.2863
COMP USDT rate (30 days avg) 6% 3.76 0.2256
COMP DAI rate (30 days avg) 7% 4.38 0.3066
Aggregate Defi rate 3.881
Bloomberg Fixed Income Indices - U.S. Government/Credit (snap reading on benchmark date) 10% 2.05 0.205
Moody’s Seasoned Aaa Corporate Bond Yield (monthly average) 15% 2.93 0.4395
30 year Fixed Rate Mortgage rate (snap reading on benchmark date) 25% 3.55 0.8875
Fei Protocol Target Rate - - 3.4725

Analysis and justification of the benchmark

One of the earliest goals of FEI lending deployments has been to subsidize and push FEI’s borrowing rate for users to a level that is competitive with other stablecoins. Therefore the most important element of the benchmark would be to track realized borrowing rates of USDT, USDC, and DAI. (totalling almost 80% of all stablecoin market cap)

The rate of these three tokens on Aave and COMP (the most used lending platforms, and ones with the overall best security track records and history data for analysis), consists of 50% of the benchmark weight. Aave has a higher weighting because its TVL is almost double that of COMP.

Historically, Defi borrowing rates can be highly volatile because utilization ratios can swing wildly due to the actions of large market actors. To minimize statistical disruption, a calculated 30 day moving average is used for Defi borrowing rate readings. This element is meant to best approximate the mainstream lending rate of the wider Defi ecosystem. It will be separately published as the Aggregate Defi Rate (ADR)

Given that one of the policy goals of FEI is to provide a lower rate than other comparable stablecoins, the target rate is designed to be structurally lower than the mainstream Defi rate. The remainder of the benchmark is designed to achieve this consistent undercutting at a sustainable rate that is difficult to manipulate.

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The 30 year Fixed Rate Mortgage rate is one of the most quoted figures across the US Dollar lending market, and consists of over 70% of all mortgage loans originated. This rate itself is heavily informed by US Prime lending rates and other key figures in the wider lending market; therefore it is a good proxy for high quality retail customer borrowing rates. Given that Defi loans are fully collateralized by risk assets, ADR can be seen as somewhat analogous to mortgage loans which are collateralized by underlying real estate and are not pure credit loans. Given time, the author theorizes that FRM rate can substantially converge with the ADR as the Defi lending market fully matures; due to the similarities in their underlying.

It is given the highest weight at 25% because it is considered to be a leading indicator for the state of the wider USD consumer lending market. High alignment with this rate would mean that FEI would not become a target for interest rate arbitrage from financial institutions, and prevent Fei Protocol from lending out funds at unsustainably low rates even if the wider Defi market was to provide artificially low borrowing rate readings for a short time.

Instead of an average rate, the snap reading on Benchmark Date will be used to reflect the latest market developments. As this is a highly watched rate, chances of statistical manipulation is negligible.

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Moody’s Seasoned Aaa Corporate Bond Yield is introduced here to provide a proxy for what borrowing rates in a fully mature lending market for borrowers of the highest credit rating might look like. Historically ADR and even 30 year FRM rates have consistently been higher than Aaa corporate Bond Yields, which can be seen as a sort of a risk premium for participating in an immature market like Defi.

Although this rate is not wholly analogous to collateralized loans to retail customers in Defi, it is introduced at 15% weight to provide a very stable anchoring point which historically trended consistently lower than the 30 year FRM rate. This would act as a way to undercut the ADR without exposing the Fei Protocol to potential arbitrages.

The US government Bonds average rate has historically been the cheapest rate that any market actor (government) can consistently borrow massive amounts in US dollars. The Bloomberg GOV/Credit index tracks a basket of bonds issued by federal and local authorities. This element is meant to consistently undercut the ADR by a large margin given they are assigned very low to zero risk by the bond market. This market is not very comparable to Defi lending markets in nature; it is introduced at a 10% weight to represent the realistic floor of USD borrowing rates and as a means to consistently achieve the policy goal of undercutting the ADR in a hard to manipulate way.

Specifications:

This proposal is currently not intended to go to a snapshot vote. It is an idea, if widely agreed in principle, that is meant to lead to other proposals that might call for the enactment of:

  • A group that would be responsible of maintaining and publishing the Fei Protocol Target Rate on a monthly basis
  • Measures that would empower existing or new bodies (such as the Optimistic Approval Squad) to enact FEI deployments that would align the prevailing borrowing rates of FEI to the FPTR
  • Development of automated algorithms that can maintain the FPTR across major lending platforms to a more accurate degree than is possible with human deployments.
  • Potentially creating a new class of fixed interest lending on Rari giving out loans at FPTR
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I think it would be great to be more intentional about rates and develop better frameworks for managing these rates. I also think fixed rate loans are very underexplored at this point, and that they should play a bigger role

the one caveat is that different platforms/pools should have different rates corresponding to their different levels of risk

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The idea of a FPTR is very good and should be moved on, in this implementation or another.

Some points:

  • Fuse is acting like a repo market so the TradFI comparison would be SOFR.
  • At MakerDAO, we have a committee for that. We try to set the target rate on DAI lending on Aave close to what we have at MakerDAO which is a bit below competition (and more stable). Target borrow rate on Aave is going to 3.5% (from 3.75% currently) even when our comparable rate ETH-A is going to 2.25%. This spread is due to the AAVE rewards.
  • Lending is also a liquidity risk and should be done within limits (hence a debt limit parameter maybe). If you provide cheap lending, people will borrow and swap to other stablecoin which will impact the peg (liquidity).
  • The common use of borrowing of FEI in Aave is to yield farm TRIBE. If you lend at 3% on Fuse it will go mainly toward this activity on Aave. Second-order effects need to be accounted for.
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Target rate is an interesting idea that has been discussed for a long time. There are a few issues, none fundamentally prevent this but do present challenges:

  1. interest rate managment is governance and risk-analysis intensive, which is directionally backward from the ethos of algorithmic mechanisms
  2. Injecting FEI into circulation to suppress rates has risks associated with the peg, and can only be done under favorable conditions. This has an opportunity cost of deploying FEI to higher yield strategies. I’m in favor of prioritizing borrowers up to a certain limit.
  3. Turbo can fill many of the gaps of high rates as it is a fundamentally expansionary/rate suppressive mechanism.
  4. This can be accomplished by tranching or fixed income protocols in a secondary market.
  5. The FeiRari pool has the entirety of TRIBE incentives and will always have high borrow demand as long as APRs stay high, subsidizing this leverage further can introduce systemic risk.
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Thanks for your insightful comments:

  1. The very spirit of deferring to bond market indices at fixed weights is to minimize risk-analysis and governance input, as they are trailing indicators and instead bows down to the incredible pricing-in ability of the bond market instead of needing to pre-empt market conditions like the Federal Reserve. I strongly believe any benchmark that may be adopted should be based on market signals, capable of high automation, and inevitably be trailing the markets.

In conjunction with SebVentures’ point regarding SOFR, this has actually been discussed with @arcology. Although it is true Fuse exhibit some elements of the repo market, the underlying is not zero-risk treasuries (at least assigned as so by the wider bond market). SOFR (and its predecessor LIBOR) has historically been pinned at near zero for extended amounts of time regardless of borrowing rates available to retail customers or even large entities. The ultimate underlying asset of the wider crypto complex (ETH), exhibit far greater volatility cf. to Treasuries. In the context of TradFI, FEI and even DAI can be viewed as secured ETH derivatives, and exhibits greater similarities to Mortgage Backed Securities. For these reasons SOFR/LIBOR and even Prime Lending Rate was struck out from the first draft of the basket.

To @SebVenture’s second point, target rate controls are inevitably complex. Though ultimately, the spirit of this proposal is that Defi financing will inevitably merge with the wider borrowing market as market actors engage in carry trades between Defi and Traditional financing sources. In that process, Defi rates would become subordinate to external TradFi monetary realities. due to the much greater market volume of the TradFi credit market.

In recognition of that eventual possibility, the measures proposed here are highly deferential to TradFI price signals. The Idea is to try to homogenize Defi Loans in the context of the bond market, and try to match what an analogous loan might be priced at in the bond market.

  1. I fully agree that rate subsidies should be paused or abandoned if the protocol run into difficulties such as if collateral ratio dips low. Though with how the benchmark is composed right now, or may be composed, there are possibilities that the target rate may rise above the general Defi Financing rate and it naturally ceases to be an interest rate subsidy program.

  2. Thats a very good point and we should explore whether Turbo itself would benefit from having a guidance interest rate. At current market volumes and time scales it is not an concern, but in the future USD inflation and arbitrage can pose a threat to protocol equity via funds borrowed freely on Turbo.

  3. I would love to hear more about that, as this idea does not truly include proposals for execution yet. It is meant to provide a starting point and a train of thought for a fairly old discussion.

  4. This is also mentioned by SebVentures, and has been discussed on and off for several months by now. TRIBE rewards are clearly inflating borrowing APRs especially on AAVE. Though as currently structured, TRIBE rewards are set to diminish and in theory taper to zero one day.

I should clarify my position further that I believe incentivizing the “deposit” side (which is the current state of affairs in FeiRari pool) is inferior in the long run to subsidizing borrowers. Users being incentivized to borrow more FEI creates future demand for the stablecoin. This especially true for FeiRari pool, as it is one of the only places where one can use TRIBE as a substantial collateral. If the incentives are hypothetically moved from deposits to borrowings, TRIBE gains an use case as owning and staking it in that pool makes a source of cheap loans available to you.

The Aave incentives pre-date FeiRari merger, and arguably has become a weak link in FEI’s overall monetary policy. I wholly agree that this represent the greatest source of second-order effects of borrowed FEI. I would concede that some sort of rate driven monetary policy might not be possible until the legacy farming programs have mostly ran their course.

Though this is a discussion well beyond the scope of a single proposal or DAO vote, which is why I wish to start exploring it now before it is tied to any concrete proposals; so we may thoroughly examine both sides of the argument when our intellectual faculties are not yet clouded by any sunk cost fallacies.

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