@inlumino - many thanks for sharing. This is fascinating.
This is very relevant to the discussion on adding stables to the Celo Reserve, so I have left related comments there: Upcoming CGP: Increase target level of stable holdings in the reserve - #10 by Pinotio.com
With respect to interest rates
- I don’t believe that Near have launched their interest rate mechanism yet.
- In general, I’m skeptical of any programs that advertise headline rates (Anchor, Near, Valora Supercharge) because fixed rates are not sustainable long term. [However, I’ll give the BIG caveat that because Valora use phone verification for each account, and limit deposits on Supercharge to $1,000, this ends up effectively being a type of UBI program (that incentivises savings) - and that makes more sense to me in line with Celo’s mission. This might seem like a small feature, but I think it makes the Supercharge program very different in practise to these other protocol-wide approaches.]
I don’t know the specific mechanism for funding USN interest (please post here if you do). One possibility is that the NEAR in the reserve is being staked/locked, and those rewards (instead of going to the NEAR in the reserve) are being paid out to USN. What is happening there is that reserve collateralisation is being reduced (because the NEAR in the reserve is not earning its staking rewards, and so NEAR in the reserve is being diluted relative to NEAR outside the reserve) in exchange for paying those NEAR rewards to cStables. It’s a trade of reserve collateral for payment of interest to stables. I’m not sure if this is a good or a bad idea overall, but it means the NEAR reserve will be under pressure to hold a high fraction of NEAR in the reserve so that there are more staking rewards that can be used to pay USN interest, and this will reduce the fraction of stables in the reserve, which increases chances of a death spiral.
Big Picture Thinking on Near/Celo
- The objective of the reserves are to provide safe collateralisation of stables. In principle, this is a service to the stable-holders.
- The income of the reserve is whatever can be earned as return on reserve assets, plus any exchange (Mento) fees.
- The costs of the reserve are interest paid to stable holders (currently zero) + impermanent loss on Mento exchanges + dilution of it’s CELO holdings (because CELO in the reserve is not currently locked and does not earn locked Celo rewards, so it is being diluted relative to locked CELO outside the reserve).
Right now, the return and collateralisation strategy of the CELO reserve is currently to be invested 94.5% in a basket of volatile cryptos (BTC, ETH and CELO) and 5.5% total in DAI and cMCO2.
It’s suboptimal that:
- The Celo reserve collateralises stable assets (cStables) almost fully with volatile cryptos. Obviously, this is a risky collateralisation strategy. Rationally, for outsiders to hold cStables, they will require a very high rate of return (probably on the order of 10%-25% as per Near, Anchor, Valora). If the Celo reserve had higher quality collateral, then outsiders would not need such high interest rates to hold funds in cStables. [Side note: Anchor is even worse than this because Terra is collateralised solely by volatile crypto and Anchor is a lending platform, so there another layer of lending+smartcontract risk as well.]
- The Celo Reserve investment strategy is 94.5% volatile cryptos, which makes it subject to strong drawdowns when Celo/BTC/ETH price fluctuates. Strong drawdowns greatly affect long term compound returns of a portfolio.
I think the long-term answers to these questions are:
- Get assets in the reserve (incl. natural capital) that have a closer correlation with cStables.
- Get assets in the reserve that provide a more conservative risk reward trade-off (currently we are taking an almost pure crypto market bet as the reserve investment strategy). This would ideally involve some assets providing yield (as commented by @markbarendt).
The problem is, for KYC and liquidity (especially liquidity on the Celo blockchain) reasons, this is going to take time.
So, in the interim, it seems best to:
- At least put more stables in the reserve (helps with correlation and also with taking a more conservative risk-reward investing approach with the reserve).
- Aggressively pursue natural capital (via the Climate Collective CGP). [We should ideally also pursue non-ReFi yielding assets, but I don’t think we have bandwidth for this and I think it’s better to focus on ReFi for mission reasons].
I know this is circuitous, but I’m getting back to interest rates and PoD…
Why offer interest?
- Interest should compensate for the risks in holding cStables (and also compensate for any opportunity cost for not earning interest on other stables, including just holding fiat). [obviously if we have a safer reserve, we would need to pay less interest.]
- In the short term, excess interest rates or payments can be used to incentivise usage/growth of Celo.
What does supercharge do?
In my view, Supercharge rewards is aimed at point 2, and it does so in a nice quasi-UBI way (which would be even nicer if we had more users outside the US and Europe).
I wonder if the Wallet and dApp council @arthurgousset (with experience shared from Valora and @jackie ) could build on Supercharge to extend it to all wallets with phone verification. It seems this could be inline with UBI goals and provide a big incentive for more wallets to adopt cStables. I also think just giving each phone number a flat amount (no saving required) per epoch is worth considering as well (more pure UBI) because it doesn’t incentivise saving. Maybe some combination…
What does Proof of Deposit do?
I see proof of Deposit doing a lot of things that are quite high level and go a lot beyond providing cStables with short term interest payments:
a. Allows us to find a market based way of setting interest rates for point #1 above on “Why Offer Interest”. Seems like something we definitely should be doing (and that no other protocols, strangely, seem to be thinking about). [Note: many blockchains have lending/borrowing platforms, but that is not the same thing, that additionally involves another credit risk.]
b. Allows us improve network security by i) creating healthy competition (which helps decentralisation) between validators [rather than the ad hoc rate of 65k paid per validator today, which incentivises large CELO holders to run multiple validators], ii) diversifying security across not just CELO but other cStables as well. So yeah, PoD helps to create a credible long run interest rate (which, btw, if we had better collateral in the reserve, should result in growth of outstanding cStables and a lowish interest rate in the long run), but PoD is about a lot more too that is worthy of careful consideration.