Aave

Overview

In this recommendation, we propose steps to continue deprecating the Aave V2 instances. As such, we recommend implementing the changes proposed in our previous recommendation on Aave v2 Ethereum, disabling borrows across all assets, raising the reserve factor in all frozen markets, and reducing interest rates in markets where bad debt constitutes a significant portion of the total outstanding debt.

Motivation

The rationale behind the previously proposed changes remains valid, ensuring a controlled and secure transition away from Aave V2.

In addition, we propose further changes aimed at standardizing the parameters in the market, improving the deprecation speed of frozen markets, and reducing the risks posed by volatile collateral assets.

In order to reduce risk we recommend disabling borrows across all assets, preventing further growth of risky debt positions. This measure ensures that positions utilizing volatile or risky collateral cannot increase their leverage within the legacy implementation. It also reduces the risk of price manipulation via oracle dependencies within the V2 instance.

We also recommend standardizing the interest rate parameters of all the frozen assets by setting a minimum base rate of 20% and a Slope 2 of 300%. This step will ensure that existing positions will be strongly incentivized to repay in order to avoid fast debt accrual that can lead to liquidations. As some of the borrow utilization of the assets in question comes from bad debt accrued over the lifespan of Aave V2, we recommend setting the reserve factor of all the frozen assets to 99%. This measure prevents Aave DAO from accruing additional net bad debt for the reasons covered in the following section.

Bad Debt

The total bad debt currently owed by Aave DAO on Aave V2 stands at approximately $954,000. This debt is primarily concentrated in stablecoins, accounting for around 88.5% of the total, with AMPL and BUSD comprising the majority.

While this value represents the nominal debt owed by the Aave DAO, thanks to the introduction of a high Reserve Factor on many of the markets, a significant portion of the accrued interest on the bad debt also represents an equal value of DAO revenue, effectively mitigating the future cost of repayment. This offsets the bad debt accrued interest, which is collected at the time of repayment of the debt itself, as the accrued Reserve Factor gets claimed in the form of aTokens once the debt is closed.

For this reason, the growth of the bad debt through interest accrual still poses minimal problems, as while the net value of the debt grows significantly slower than the debt itself, the DAO will still require the use of a bigger capital in order to start the repayment process. While interest rate adjustments have been made in the past to mitigate this issue, we recommend minimizing the interest rate curve of assets where over 90% of the borrowed value is bad debt. The current annual virtual bad debt accrual remains at 24% APR, which represents minimal issues to the Aave DAO.

For additional context, the value of the bad debt on the 1st of August 2024 was $706,000, and we can safely assume that the majority of the growth in value since then has been virtual.

Roughly 98% of the total accrued bad debt is currently outstanding on the Ethereum instance with only 3,400$ of bad debt being accrued between the Avalanche and Polygon instances.

The positions that constitute the largest bad debt holders are depicted in the chart below. Notably, the top ten debtors predominantly hold AMPL or BUSD debt.

The markets with the highest percentage of borrows represented by bad debt are BUSD, MANA, and TUSD. Other markets, including AMPL, GUSD, sUSD, and renFIL, also exhibit substantial bad debt but to a lesser extent.

Given this distribution of positions and bad debt, we recommend reducing the interest rate for the markets where the Bad Debt represents the majority of the borrows to 1% (>90%), while for the markets where a significant part is still represented by user’s demand with a 20% base and a 300% Slope 2.

Specification

Ethereum V2

Implement previously proposed modifications to Aave V2 as per here.

Asset	Chain	Current RF	Recommended RF	Current Slope2	Recommended Slope2
USDC	Ethereum	85%	70%	60%	60%
USDT	Ethereum	85%	70%	100%	60%
DAI	Ethereum	85%	70%	75%	60%

Disable new borrows across all assets in Aave V2 to prevent further debt accumulation.

Asset	Chain	Borrowable Current Value	Borrowable Recommended
WAVAX	Avalanche	Yes	No
DAI.e	Avalanche	Yes	No
USDT.e	Avalanche	Yes	No
WETH.e	Avalanche	Yes	No
WBTC.e	Avalanche	Yes	No
ENJ	Ethereum	Yes	No
USDT	Ethereum	Yes	No
KNC	Ethereum	Yes	No
renFIL	Ethereum	Yes	No
DAI	Ethereum	Yes	No
WBTC	Ethereum	Yes	No
UST	Ethereum	Yes	No
BUSD	Ethereum	Yes	No
USDC	Ethereum	Yes	No
MANA	Ethereum	Yes	No
YFI	Ethereum	Yes	No
RAI	Ethereum	Yes	No
AMPL	Ethereum	Yes	No
WETH	Ethereum	Yes	No
FEI	Ethereum	Yes	No
CRV	Polygon	Yes	No
LINK	Polygon	Yes	No
BAL	Polygon	Yes	No
USDT	Polygon	Yes	No
WETH	Polygon	Yes	No
USDC.e	Polygon	Yes	No
WBTC	Polygon	Yes	No
WPOL	Polygon	Yes	No
DAI	Polygon	Yes	No

Adjust interest rate parameters in markets where bad debt constitutes a significant portion of the total outstanding debt, ensuring that accrual rates do not exacerbate financial losses.

Asset	Chain	Current Base	Current Slope 1	Current Slope 2	Current UOptimal	Current Reserve Factor	Recommended Base	Recommended Slope 1	Recommended Slope 2	Recommended UOptimal	Recommended Reserve Factor
BUSD	Ethereum	10%	0%	0%	1%	99.99%	1%	0%	0%	1%	-
ZRX	Ethereum	20%	0%	300%	45%	99.99%	1%	0%	0%	1%	-
BAT	Ethereum	20%	0%	300%	45%	99.99%	1%	0%	0%	1%	-
MANA	Ethereum	20%	0%	300%	45%	99.99%	1%	0%	0%	1%	-
FEI	Ethereum	0%	4%	100%	1%	99.99%	20%	0%	300%	45%	-
sUSD	Ethereum	3%	15%	200%	20%	99.99%	20%	0%	300%	45%	-
LUSD	Ethereum	3%	15%	200%	20%	99.99%	20%	0%	300%	45%	-
USDP	Ethereum	3%	15%	200%	20%	99.99%	20%	0%	300%	45%	-
FRAX	Ethereum	3%	15%	200%	20%	99.99%	20%	0%	300%	45%	-
GUSD	Ethereum	3%	15%	200%	20%	99.99%	20%	0%	300%	45%	-
TUSD	Ethereum	10%	0%	0%	1%	99.99%	20%	-	300%	45%	-
renFIL	Ethereum	0%	0%	0%	0%	35.00%	20%	-	300%	45%	99.99%
AAVE	Ethereum	0%	0%	0%	45%	0.00%	20%	-	300%	-	99.99%
LINK	Ethereum	0%	7%	300%	45%	90.00%	20%	0%	-	-	99.99%
UST	Ethereum	20%	0%	300%	80%	99.99%	-	0%	-	45%	-
RAI	Ethereum	20%	0%	300%	80%	99.99%	-	-	-	45%	-
KNC	Ethereum	20%	0%	300%	65%	99.99%	-	-	-	45%	-
AMPL	Ethereum	20%	0%	300%	80%	99.99%	-	-	-	45%	-
BAL	Ethereum	20%	0%	300%	80%	99.99%	-	-	-	45%	-
DPI	Ethereum	20%	0%	300%	50%	99.99%	-	-	-	45%	-
SNX	Ethereum	20%	0%	300%	80%	99.99%	-	-	-	45%	-
UNI	Ethereum	20%	0%	300%	45%	99.99%	-	0%	-	-	-
CRV	Ethereum	20%	0%	300%	45%	99.99%	-	0%	-	-	-
YFI	Ethereum	20%	0%	300%	45%	99.99%	-	0%	-	-	-
BAL	Polygon	5%	50%	134%	20%	99.99%	20%	0%	300%	45%	-
GHST	Polygon	0%	50%	134%	10%	99.99%	20%	0%	300%	45%	-
CRV	Polygon	3%	50%	134%	10%	99.99%	20%	0%	300%	45%	-
LINK	Polygon	0%	50%	134%	10%	99.99%	20%	0%	300%	45%	-
AAVE	Polygon	0%	0%	0%	45%	0.00%	20%	-	300%	-	99.99%
DPI	Polygon	0%	7%	300%	45%	20.00%	20%	0%	-	-	99.99%
SUSHI	Polygon	0%	7%	300%	45%	35.00%	20%	0%	-	-	99.99%
WBTC.e	Avalanche	0%	7%	300%	45%	85.00%	20%	0%	-	-	99.99%
AAVE.e	Avalanche	0%	7%	300%	45%	20.00%	20%	0%	-	-	99.99%