Bolstering Moonwell's Safety Module: Rewarding Stakers via Reserve Auctions

Summary

This proposal is a continuation of MIP-X05, and aims to further enhance governance participation and bolster Moonwell's Safety Module by directing excess protocol revenue toward staking rewards. Currently, Moonwell generates significant protocol revenue, with $386.1K in revenue and over $2.1M in fees for lenders in December 2024 alone. However, this revenue remains idle as reserves in the core markets. We would like to propose an onchain auction system where excess protocol revenue is auctioned for WELL tokens, which are then allocated to the Safety Module Ecosystem Reserve. This approach will:

• Increase staking rewards for WELL stakers in the Safety Module
• Enhance security through greater shortfall insurance and fostering stronger governance engagement
• Encourage continued governance participation We seek to gauge community sentiment through this snapshot temperature check vote before moving forward with an onchain vote in the next week. Please also review the associated forum post for additional details and to share any thoughts, questions, or concerns that you may have.

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Moonwell Protocol Revenue Generation

Current Revenue Growth

Moonwell is one of the top revenue-generating protocols across all deployed networks. In December 2024 alone, the protocol generated $386.1K in revenue and over $2.1M in fees for lenders. Until now, that protocol revenue has been largely idle, stored in core markets as reserves, which act as extra liquidity to facilitate user withdrawals.

New Sources of Revenue

New revenue sources have come online in recent weeks and months that should continue to increase protocol revenue, primarily in three areas:

• Vault Performance Fees: Moonwell’s Flagship and Frontier vaults generate performance fees, captured as protocol revenue and added to core market reserves. The retail borrowing demand for USDC from Coinbase Bitcoin borrowers is expected to significantly increase these fees in the coming months as their new borrow product continues to be rolled out to more users.
• Oracle Extracted Value (OEV): A pilot for Oracle Extracted Value launched on Optimism. Once proven successful, it will be put up to a vote to expand to Base and Optimism markets, significantly increasing protocol revenue. According to IntoTheBlock data, liquidators have made $2.09M in profit from Base core market liquidations alone. With the new OEV solution, 99% of that could be recognized as protocol revenue.
• Leveraged Bitcoin Restaking Markets: New markets for Lombard BTC and the cbBTC Frontier vault have positioned Moonwell as the premier venue for leveraged Bitcoin restaking, increasing TVL and revenue in the coming months.

Why This Matters

Moonwell has focused relentlessly on capital efficiency, fee capture, and revenue growth. Notably, much of Morpho’s TVL originates from Moonwell’s vaults, though DeFi Llama does not attribute that TVL to Moonwell. However, what truly matters is capital efficiency and revenue generation, and Moonwell generates more revenue per $ of TVL than any other lending app on Base.

Where Should This Revenue Go?

The Case for Safety Module Rewards

For years, DeFi protocols have debated how to allocate excess revenue effectively. Many options carry excessive regulatory risk, making them unfeasible. After months of consultation with top legal experts, Moonwell contributors have come up with what we believe to be a sustainable mechanism that aligns all stakeholder incentives. As a continuation of the effort to increase governance participation, we propose that **excess protocol revenue be auctioned for WELL tokens and allocated to the Safety Module Ecosystem Reserve.**The Ecosystem Reserve is a smart contract that holds protocol reserves and is currently used to reward Safety Module stakers for their role in shortfall insurance and governance participation. To achieve this, Moonwell contributors propose implementing onchain auctions via smart contracts:

• Excess ETH, USDC, cbBTC, wstETH, cbETH, rETH, AERO, and other reserves will be auctioned for WELL.
• The acquired WELL will be transferred to the Safety Module Ecosystem Reserve to bolster staking rewards.

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How the Auction System Works

This system introduces a new onchain auction contract that allows WELL tokens to be used in exchange for reserve assets. The contract will conduct multiple mini-auctions throughout each cycle, selling reserve assets over time. This approach:

• Averages out sale prices over time, effectively emulating a TWAP (Time-Weighted Average Price) strategy.
• Uses a linear decay function that initially applies a premium, then gradually introduces a discount relative to the Chainlink price.
• Caches prices at each step to ensure a structured, predictable auction process.
• Sends proceeds to the WELL Holding contract, which can then be used to fund the Safety Module via governance proposals.

Step-by-Step Walkthrough

Here’s how the process will work:

1. Automated Governance Proposal: The governance proposal that rebalances liquidity incentives will include additional calls to withdraw excess protocol revenue to the Governor smart contract.
   • While the example focuses on WETH and USDC, this process applies to all relevant markets.
2. Token Transfer to Auction Contracts: The same governance proposal will transfer WETH, USDC, and other tokens to separate auction contracts for each asset, initiating a fully onchain, decentralized auction.
   • Auctions begin with 100% of the assets (WETH, USDC, etc.), and by the end of a two-week period, they will be converted to 100% WELL.
3. Auction Mechanics:
   • The total auctioned tokens are divided into 84 equal mini-auctions, each lasting 4 hours.
   • Each mini-auction starts above the Chainlink price and slowly decays over 4 hours until a market participant (typically a MEV bot) swaps WELL for the asset.
   • By splitting the auction into 84 time-weighted auctions, the system ensures optimal price execution while avoiding unnecessary swap fees and gas costs.
4. Final Settlement & Distribution:
   • Four weeks later (two weeks after the auctions end), the next automated liquidity incentive proposal will transfer the acquired WELL to the Safety Module Ecosystem Reserve.
   • Governance will then adjust the staking rate to enable the higher staking reward APR.
5. Claiming Staking Rewards:
   • Safety Module stakers can claim rewards at any time, as they do currently.
   • No structural changes to the Safety Module architecture are proposed—the Ecosystem Reserve was designed for this purpose.

Determining Safe Reserve Withdrawal Levels

A key question is how much of each market's reserves should be allocated to these auctions?

• Input from Gauntlet and other risk experts is critical in establishing safe reserve thresholds for each core market.
• These thresholds should be dynamic—if market conditions shift significantly, Gauntlet and other contributors can provide updated guidance, which can then be reflected in governance reward speed proposals.

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Projected Impact on Staking Rewards

How much would this bolster Safety Module staking rewards?

• In December 2024, the automated liquidity incentives proposal allocated 4,394,963.08 WELL to Safety Module stakers on Base.
  • At today’s price of $0.039, that equates to ~$171,403.56 in rewards and a 7.42% APR.
• In December 2024, Moonwell also generated ~$352,777 in protocol revenue on Base, according to Token Terminal. Redirecting protocol revenue to Safety Module stakers could increase staking rewards by an estimated 3.06x, boosting APR to 22.71%.

Note: Estimates are subject to market conditions and may vary.

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Open Questions

• For Gauntlet, BlockAnalitica, B. Protocol, and other risk-focused contributors: what should we keep in each market as a healthy level of reserves?
• Should we fully distribute all the WELL obtained through the auctions to Safety Module stakers every 4 weeks, or should the staking APR be capped at some lower level, such as 20%?
  • Some contributors have proposed capping the staking APR at 20%, which would allow some WELL to stay in the Safety Module Ecosystem Reserve, which would be beneficial to keep the staking APR high during bear markets, or to further bolster the shortfall insurance.
• What challenges or issues do you see with this proposal?

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Voting Options

✅ Yay – Support implementing the above model to auction excess protocol reserves into staking rewards, strengthening governance participation and shortfall insurance. ❌Nay – Do not implement this change. ⚪Abstain – No preference on the decision.