Increase PremiumRedeemFee, PunishmentFee, and Liquidation threshold for all vault collaterals by **3%**

10mos ago
1 Comments

I propose to increase the Premium Redeem Fee, Punishment Fee, and Liquidation threshold for all vault collaterals by 3%.

  • Increase Premium Redeem Fee 5% -> 8%
  • Increase Punishment Fee 2% -> 5%
  • Increase Liquidation Threshold 5% -> 8% (105% -> 108%) for all vault collaterals (DOT, USDT, USDC, VDOT, qDOT, qUSDT, qUSDC)

Background:

If a vault falls below the "Premium Redeem" threshold, any user can redeem iBTC against their vault for a premium. This encourages vaults to stay above the premium redeem threshold and therefore a safe distance from liquidation. Similarly, the Liquidation Threshold (currently 105%) determines the collateralization threshold at which a vault will automatically be liquidated by the system, but also what reward users would receive by burning excess iBTC (105% - 100% = 5% premium). Finally, the Punishment Fee is how much a vault is penalized if they do not process an iBTC redeem request within the timeout period (currently 6 BTC confirmations and 300 Interlay blocks within 24 hours).

Historically, a Premium Redeem earned 10%, Punishment Fee was 10%, and Liquidation Thresholds were 115%-135%. However, there was a push in 2023 to reduce collateral requirements for vaults and reduce several fees to reduce vault operation risk, all to increase iBTC capacity. Think of them as experiments to see how the market would react. The Premium Redeems were reduced to 5%, Punishment Fee reduced to 2%, and Liquidation Thresholds reduced to 105% -> 5% premium.
see Interlay ref 77 to Reduce Liquidation Thresholds to 105%

Recent iBTC Demand vs Capacity:

However, in June 2024 the Hydra Omnipool and Stellaswap liquidity campaigns began with Polkadot Treasury incentives, driving increased demand for iBTC to farm rewards. Along with this the INTR price has been falling, reducing vault rewards and overall vault collateral has been reducing. Therefore there is high demand but no capacity to mint more iBTC and this has driven iBTC to trade at a 6% premium. (Currently 0.1 iBTC sells for 7315 USDT on Hydra, a 5.3% premium)

Last week there was a big drop in DOT price, and at least two vaults were in the 110-115% collateralization range where other users should have premium redeemed against them. However, with iBTC selling at a 6% premium and an Interlay Premium Redeem only being rewarded with 5% it was not in anyone's best interest to redeem iBTC to BTC via one of the vaults in jeopardy. Therefore one of the system safeguards was breaking down.

The long-term solution is of course finding ways to increase iBTC vault capacity. However, in the short-term we need to modify the vault parameters to make it profitable for people to burn excess iBTC or premium redeem against vaults even with the elevated iBTC prices, to keep the system in balance.

Goals/Guidelines:

  • Liquidation Threshold + Punishment Fee + buffer < Premium Redeem Collateralization Threshold (see Interlay disc 37)
  • Premium Redeem Fee > iBTC price premium + BTC tx fee
  • Reward to Burn iBTC > iBTC price premium

Threshold Updates:

Current Thresholds:

Collateral Liquidation Threshold Premium Redeem Threshold Secure Mint Threshold System Collateral Ceiling
DOT 105% 115% 130% 2,450,000
qDOT 105% 115% 130% 2,500,000
USDT 105% 115% 150% 2,000,000
qUSDT 105% 115% 150% 74,876,968
USDC 105% 115% 155% 2,000,000
qUSDC 105% 115% 155% 75,000,000
vDOT 105% 115% 135% 1,500,000

Suggested Thresholds:

Collateral Liquidation Threshold Premium Redeem Threshold Secure Mint Threshold System Collateral Ceiling
DOT 108% 120% 135% 2,450,000
qDOT 108% 120% 135% 2,500,000
USDT 108% 120% 155% 2,000,000
qUSDT 108% 120% 155% 74,876,968
USDC 108% 120% 160% 2,000,000
qUSDC 108% 120% 160% 75,000,000
vDOT 108% 120% 140% 1,500,000

Note that there are currently six vaults in the 120-125% C range, nine vaults in the 115-120% C range, and one vault at 114% collateralization. With the proposed thresholds above, all vaults under 120% collateralization should see premium redeems, losing some collateral but bringing their collateralizations back above 120%.

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There are three parts to this, two of which are superfluous in my opinion.

  • Increase Liquidation Threshold 5% -> 8%
    • This is not enough. There should be a clear advantage to burning your iBTC over trading it in the open market. Historically, that premium was 5% as iBTC was trading at par.
    • When a liquidation occurs, Interlay has two buckets: the collateral bucket and the iBTC debt bucket. It tries to fill the debt by offering the collateral. $108 in VDOT would incentivize the burning of $100 in iBTC. If nobody acts quickly on this and the price of VDOT slides by just 2.7%, the collateral bucket is worth only $105, which is again less than what Hydration markets are paying.
    • Liquidation Threshold should be increased to 10% -- 105% -> 110%
  • Increase Premium Redeem Fee 5% -> 8%
    • While premium redeem is a safety mechanism, it is nowhere near as mission critical as a good liquidation system. It acts mainly as an incentive for outsiders to help vaults rebalance their collateral ratios. Therefore, it should be up to the vaults to decide whether they want this safety mechanism updated. For example, Mellow Yellow has stated their opposition to this change.
    • The change would surprise some vaults that currently feel safe. Increasing liquidation threshold would automatically push up premium redeem threshold and bring these vaults into premium redeem territory.
    • Premium Redeem Fee should be held at 5%
  • Increase Punishment Fee 2% -> 5%
    • I don't understand why this should be changed. The time the vault has to execute the redemption request was cut to 24h from 48h when the fee was lowered. Increasing this would punish vaults too heavily for infrastructure issues such as falling behind on their bitcoin chain tips.
    • Punishment Fee should be held at 2%

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