Tl;dr.

• KINT and INTR Vault block rewards are currently too high, considering market conditions and in comparison to competitors / projects with similar risk profile.
• This proposal suggests to adjust Vault block rewards to a more sustainable level, updating the KSM / DOT collateral requirements to competitive and more capital-efficient rates, and introducing regular review cycles to assess ROI for protocol and Vault operators.
• The saved funding will remain with the network treasury, to be used as governance decides, e.g.. to bootstrap kBTC/iBTC growth as market conditions improve and help build liquidity in the native AMM and lending protocols set to launch on Kintsugi and Interlay in early 2023 (more details in upcoming Interlay 2.0 whitepaper - read 2.0 roadmap announcement).

Introduction: Vaults on Kintsugi/Interlay

Vaults are the heart of the Interlay & Kintsugi networks: they secure BTC while kBTC/iBTC is being used in DeFi. To do so, they deposit collateral in different assets, insuring users against exchange rate fluctuations and loss of BTC. As such, the costs of running a Vault are twofold:

1. Infrastructure costs and maintenance labor for running the Vault software
2. Capital (opportunity) costs for putting up collateral

During the bootstrap phase (while the Interlay and Kintsugi protocols do not generate sufficient bridge revenue to cover all operational costs), the treasury pays block rewards to Vaults in the native KINT (on Kintsugi) and INTR (on Interlay) tokens. 30% of the treasury was proposed to be used for this purpose over the first 4 years of network operation, 12% in the 1st, 9% in the 2nd, 6% in the 3rd and 3% in the 4th year. Block rewards are split among Vaults proportional to how much BTC has been minted with them (for an individual Vault: vault_BTC / total_BTC_minted).

Problem

The current KINT and INTR reward emission is unsustainable:

• ~80% APR on Kintsugi
• ~65% APR on Interlay

as opposed to what can be observed on the market from competitors/node operations comparable to the Kintsugi / Interlay risk profile: between 12% and 22.8% [3].

This creates a negative feedback loop: there is too much emission, disproportional to the adoption curve, and Vaults are incentivized to sell KINT/INTR in anticipation of being able to repurchase it cheaper at a later point in time. This in turn creates a downwards spiral of both token prices that slowly but steadily burns treasury funding and reduces returns for Vaults (despite the high emission).

Goal

The goal of this proposal is to adjust Vault block reward rates to be more sustainable while keeping incentives for operators high enough - and more reliable.

Solution

1) Reduce collateral thresholds.

The latest collateral risk models [1] suggest the following collateral thresholds for KSM (on Kintsugi) and DOT (on Interlay):

KSM (on Kintsugi)

• liquidation: 130%
• premium-redeem: 145%
• secure (min. when minting): 160%

DOT (on Interlay)

• liquidation: 125%
• premium-redeem: 140%
• secure (min. when minting): 155%

This change reduces the capital requirements of Vaults by ~40%.

For more information on the meaning of individual thresholds, see [2]

2) Adjust Vault block rewards to competition.

The proposal is to adjust the Vault rewards such that:

• APR on Kintsugi is ~30% assuming the amount of collateral locked at the time of this proposal. This proposal updates the block reward from 0.456621004566 KINT to 0.102803978513969 KINT.
• APR on Interlay is ~25% assuming the amount of collateral locked at the time of this proposal. This proposal updates the block reward from 45.6621004566 INTR to 9.866085649312430 INTR.

3) Regular Review & Adjustment of Vault Economics.

Rather than having a static model, we propose that Vault economics be reviewed on a regular basis, allowing to react and adjust for external/macroeconomic events.

The community, including Vault operators, can make recommendations/requests to adjust the Vault rewards schedule via the Governance portal (guides provided).

The process to adjust rewards will be greatly simplified over the next months with upcoming improvements to governance (more details are incoming in the Interlay 2.0 whitepaper).

Expected Result

The optimization of collateral thresholds combined with the adjusted reward schedule is expected to reduce emissions as follows:

• KINT emission by ~78%
• INTR emission by ~79%

Why should community vote in favor of this proposal?

This proposal makes a big step to improving the economic stability and outlook of both Kintsugi and Interlay.

The current emission schedule was conceived during a growing crypto market, in anticipation of reaching significant iBTC targets by EOY 2022. However, due to recent macro-economic events in crypto (Luna, 3AC, Celsius and now FTX), as well as the two hacks (Nomad impacting Moonbeam and aUSD on Acala) affecting Polkadot, the growth of DeFi on Dotsama has not been as fast as hoped. As a result, kBTC and iBTC utilization rates are low, with most BTC sitting on Kintsugi/Interlay.

The high initial emission was also a measure to reward early technical risk and to cover the high collateral requirements imposed at launch (260% over-collateralization for KSM/DOT Vaults). The technical risk of the bridge can be considered significantly reduced by now. The bridge has been operating successfully since March 2022 on Kintsugi and since August 2022 on Interlay, withstanding the recent market turbulences. The removal of the aggressive BTC theft reporting [4] has also greatly reduced the risk of wrongfully slashing Vaults. The proposed reduction of collateral thresholds to competitive rates also constitutes a big step towards Vault capital efficiency.

References

[1] Interlay Vault collateral risk modelling framework. https://github.com/interlay/collateralization-analysis

[2] Vault collateral thresholds. https://docs.interlay.io/#/vault/overview?id=collateral

[3] APR comparison to similar projects. https://api.ipfsbrowser.com/ipfs/get.php?hash=QmPhP8utFLhharELDeN6Njbc2234DGxnc4A73wxf2JHwPJ

[4] Kintsugi proposal discussing removing theft-reporting. https://kintsugi.subsquare.io/democracy/referendum/52

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EDIT 23 Nov 2022 15:34 UTC: added link to Interlay 2.0 roadmap announcement