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