Reserve Factor Consensus for the Compound Protocol

Forum discussion can be found here.

To facilitate community discussion and establish consensus regarding the next steps on Reserve Factors for Compound II, Gauntlet provides the following 3 options. Below, we outline the tradeoffs for each option in more detail. Gauntlet recommends that options 1 and 3 are the most prudent options. Since adjusting Reserve Factors is as much a matter of business strategy as it is of market risk, it is important for the community to find consensus.

1. Decrease Reserve Factors by 0.025 for USDT and DAI - since reserves are currently high enough to cover the 95% tail scenarios showing $0 VaR for all collateral assets, and borrows have sharply declined on the protocol, reducing Reserve Factors is an opportunity to bring interest rates close to the market rate with the goal of driving borrow activity while also gathering data around borrower and supplier elasticity. These assets are also not part of the initial Compound III roll-out and, therefore, relatively isolated from that market.

   Limitations and Tradeoffs: Since we do not have data on borrower elasticity, we cannot model borrower behavior. If users are inelastic to interest rate changes, the reduced reserve factor might result in lost revenues for the protocol. This risk may be acceptable given the low borrow volume at the moment.

2. Increase Reserve Factors by 0.025 for USDT and DAI - proponents of this option may assume user behavior is inelastic to interest rates, therefore allowing the protocol to capture a larger share of the revenue. Any change in reserve factor would enable the community to gather data on user elasticity to build better models in the future.

   While we support either option to gather data and improve models, Gauntlet does not recommend this option since any user elasticity with respect to this change would push interest rates farther away from the market rate as liquidity leaves the protocol.

   Limitations and Tradeoffs: same as above - since we do not have data on elasticity, we cannot model behavior. If users are elastic to this change, an increase in reserve factor could result in decreased revenues for the protocol, the extent to which is unknown given the limited data.

3. Wait until Compound III is live - with the changing dynamics to be brought on by Compound III (reserve factor will no longer be set as a global parameter), the community may decide to wait to change reserve factors.

   The tradeoff here is that we will collect no information on user elasticity.

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