This proposal presents a draft framework that Notional governance can follow to manage updates to variable and fixed interest rate parameters on the protocol.
Motivation
Market conditions and interest rate environments change quickly and the protocol’s interest rate parameters are very important in determining the success of the protocol in these conditions. Variable and fixed rate parameter choices affect the protocol’s ability to attract deposits as well as the profitability and liquidity profile of the nToken.
Updating interest rate parameters is also very sensitive because it changes the terms for Notional users. While interest rate updates will be necessary for the protocol to grow and respond to market conditions, we recognize that uncertainty around interest rate policy is bad for users. We hope that this framework will make it more clear how updates will be made so that users know what to expect.
Variable interest rate curve parameterization
Proper variable interest rate parameters can help the protocol grow, and incorrectly set parameters will hurt that process.
If variable interest rate curves are set too low, there may be lots of demand to borrow via leveraged vaults, but not enough interest to lend. This will lead to the protocol consistently operating at high utilizations but being unable to attract deposits.
Conversely, if interest rate curves are set too high, there may not be enough demand to borrow. This will lead to low utilization and again, the protocol will be unable to attract deposits and scale.
Setting variable interest rates
We propose to update variable interest rate parameters once every two weeks based on Notional utilization and an assessment of comparable opportunities in the market. Comparable opportunities and protocols may change as market conditions change, but for now, yields on Gearbox, Pendle, and Instadapp Fluid will be used as benchmarks that Notional will seek to match.
We will publish recommendations to snapshot on the first and third Friday of each month for ratification over the weekend on a 2-day vote. If the changes are voted through, new parameters will be implemented on the following Monday.
Fixed interest rate curve parameterization
Fixed interest rate curve parameters determine the max range of fixed interest rates for each maturity and currency. This has big impacts on Notional UX:
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If the max range of fixed rates is too narrow, the protocol will have a difficult time attracting fixed rate lenders when the nToken is highly utilized. This means that nTokens have a higher risk of illiquidity.
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If the max range of fixed rates is too wide, fixed rate liquidity will be utilized less efficiently and the nToken will also be riskier to hold because fCash prices would be allowed to move more.
On balance, we believe it is prudent to lean toward setting wide interest rate ranges to minimize the risk of being unable to attract lenders. This risk is significant because currently fixed rate curves can only be updated every three months.
Setting fixed interest rates
We propose to update fixed interest rate parameters every three months, two weeks before the quarterly roll. Our recommendations will be based on variable and fixed rate activity on Notional in the previous quarter + comparable market opportunities.
Interest rate policy in the future
We see the interest rate policy described here as an intermediary step along. Ultimately, we would expect to progressively automate this policy and remove human judgment from the process to bolster trust and predictability for all Notional users.
We propose to revisit this policy in 3 months, analyze how it was implemented and determine if any changes should be made and what could be automated going forward.