IIP-17: Introduction of an AAVE v3 ETH borrow rate derivative and an eETH pool
Summary
Which new index and/or derivative should the IPOR protocol introduce?
The IPOR protocol shall introduce an interest rate derivative based on the AAVE v3 (mainnet) ETH borrow rate.
The swaps will be denominated in $ETH and underwritten by a $weETH (wrapped ether.fi staked ETH) pool that will be created. The swaps are paid out in $weETH.
Motivation
Who makes this proposal?
Ether.fi Team
Why?
The ETH borrowing market is currently one of the most important in DeFi. There is a lot of demand for ETH, especially in leveraged looping strategies.
Swaps based on a single interest rate (the ETH borrow interest rate on Aave Ethereum v3) allow users to perfectly hedge their borrowing position, making them an important component for leveraged looping products.
The choice of the pool's asset is eETH in order to offer the liquidity providers of the IPOR protocol an opportunity to earn Eigenlayer points, Ether.fi loyalty points, ETH staking yield and restaking yield in addition to trading fees and pwIPOR rewards.
Market Size
What size and structure does the market have? How has the size of the market developed over time?
An eETH pool is feasible at this time given the popularity of the token, the alignment with the restaking narrative, and the potential effect of the restaking yields on the Ethereum borrowing rate.
Currently there are hundreds of millions of dollars in leveraged looping activities for ETH/stETH which shows a product market fit for borrowing of ETH and a need to hedge the rate exposure. This demand can be extrapolated with the rising popularity of the restaking narrative which could also affect the APR landscape of ETH and stETH, and its potential spillover into the ETH borrowing rates. Therefore the timing of such an instrument provides utility and fills a market need.
Interest Rates
What are the current and historical rates of this market?
(Interest) Rate Model
Which model determines the rates?
https://docs.aave.com/risk/liquidity-risk/borrow-interest-rate
Can the interest rate model be changed?
Yes.
Are rates governed or market driven?
Market driven, but rate parameters can be changed by governance.
Are there currently additional (token) incentives for market participants or are they planned?
No.
Trading
What swap volume is expected in the short, medium and long term?
Currently the ETH borrow volume on Aave v3 mainnet is ~$283M. If each borrower hedged the borrow rate via an IPOR swap, this would result in a notional trading volume of $283M and an annual fee income of $1,415,000.
Which market participants (hedgers, speculators, arbitrageurs, etc.) contribute to what proportion of the swap volume? Is the natural demand more on the pay fixed side, the receive fixed side, or balanced?
The natural demand is likely to come largely from pay fixed traders who use the swap for eETH/ETH looping.
Integrations and products
Are there other protocols that could integrate this derivative? Can additional products be built with this derivative?
The derivative could be used for looping products, e.g. from ETH Saver or from Instadapp.
Pool
How big is the market cap of the asset (eETH)?
more than $1B
What return will liquidity providers expect? What is the market risk-adjusted return for this asset? Are there incentives for liquidity providers?
Should part of the pwIPOR liquidity mining emissions be allocated to the new pool? (note: the recommendation about the amount will be made by the Economics Workgroup)
Yes.
Are there any token incentives from third parties?
No.
Asset Management
Asset management is not necessary. Ether.fi will withlist the pool so that liquidity providers can earn EigenLayer restaking points and ether.fi loyalty points.
Risks
What risks exist?
The risks are comparable to the AAVE markets already integrated into the IPOR stablecoin indices.
Can the index be manipulated?
Theoretically, the borrow rate could be influenced by governance decisions. However, the rate is heavily dependent on supply and demand, so the influence is likely to be considered small.
What does the user profile of the market look like? Are there any larger market participants (so called whales)? Is there currently or has there been a concentration in the past?
The user profile of the AAVE v3 mainnet ETH market is mixed. There are both larger and smaller market participants.
Is the market audited?
Are there regulatory risks?
No particular risks are apparent.
Costs
Who bears the development costs of the new index and the instruments? What are the subsidies for the development costs?
The IPOR Labs team has already signaled that the costs considered for implementing these proposals fall within the software development scope and services rendered and paid for from the protocol’s initial funding.
What maintenance will be required? How much are the annual maintenance costs and who covers them?
Maintenance costs will be borne by the IPOR Protocol for as long as the instruments are supported. The duration of the instrument will be determined by usage of the pool and instruments, fee generation, and ultimately a decision by DAO governance to maintain or deprecate any IPOR instrument.
Who will subsidize the index publications costs in the bootstrapping phase?
There are no index publications for the instrument. The Aave v3 ETH borrowing rate is already published on-chain in the Aave smart contracts. The particular instrument is not published to chain by the IPOR Oracle so there are no on-chain fees for publication. The risk oracle is only used in pricing instruments and therefore does not incur on-chain fees.
Technical Details
The goal of the modifications is to rely entirely on the floating rate coming from the debt token of AAVE. The value of the “IBT” can be read from the contract directly: https://etherscan.io/address/0x7B4EB56E7CD4b454BA8ff71E4518426369a138a3#readContract
Using function: getReserveData that returns parameter: variableBorrowIndex
That means that the index would not have to be printed via the IPOR oracle. That would simplify the overall architecture and reduce the maintenance cost. If this is feasible, the AMM would need to be modified to accommodate an alternative way of calculating the swap’s PnL. The backend component of the risk oracle would require standard modifications to accommodate the new offered rate model.
Off-Chain Vote
Timeline
Feb 20, 2024Proposal created
Feb 21, 2024Proposal vote started
Feb 24, 2024Proposal vote ended
Feb 24, 2024Proposal updated