Setting Interest Rates for ETH Instant Unstake Loans

We will need to establish an accurate and fair pricing model for our Instant Unstake Model. Our algorithms must solve for a range of parameters, but arguably the most critical is the borrow interest rate/discount rate at which we will price the Instant Unstake purchases.

How do We Build the Discount Rate in Our Model?

Within the context of a P2Pool system our interest rate will be determined by available liquidity in the system. Of course that liquidity can take several shapes:

  1. ETH and WETH

  2. aETH, cETH, stETH, and/or other ETH derivatives on Parallel

Within the P2P/P2Pool hybrid model we will likewise add a marketplace for these stakefish staking NFT’s and outright P2P purchases. Below is the schematic of the Parallel Instant Unstake NFT router:

Here we focus on step 1. as this itself will be its own router within the above tokens.

Within Step 1:

  • NB: Implicit in the above is that instantaneous loans have zero duration risk. But as we will discuss in the next section we will need to adjust borrow rates for the relevant duration risk.

Of course even beyond the stakefish NFT router we want to know how much a specific staking position is worth. And indeed we study pricing models and setting interest rates for these loans below.

Duration Risk and Overcollateralized DeFi Loans

The well-understood Aave/Compound lending model creates overcollateralized open-ended loans with no specific requirement nor immediate need to assign duration risk to the loan. Or in other words, the borrower pays the same interest rate regardless of how long they maintain their borrow position. Why?

  • Overcollateralization with quality collateral means the lender can recoup any principal and interest owed upon a successful liquidation.

There nonetheless remains duration risk for both the borrow and the lender, specifically with regard to interest rates:

  • Lender: Given that interest rates vary by Utilization, the Lender may receive a worse return than they anticipated if Utilization within the pool declines. Both of these risks grow as a function of Duration and Utilization:

    • The interest rate may in fact drop below the Lender’s discount rate and thus this may prove unprofitable. This can also be referred to as Convexity risk, or the change in value of an existing lending position on a rise or fall in its interest rate.

  • Borrower: The Borrower may ultimately pay a higher interest rate than they expected if Utilization rises.

    • This interest rate may rise above the Borrower’s discount rate and this borrow may prove unprofitable. This risk grows as a function of Duration and Utilization.

Summarizing Risks Inherent to ETH Unstaking Loans - Duration/Convexity and Slashing

  1. Liquidity risk - This is the risk that ETH pool Utilization will surge and leave the ETH supplier without the ability to withdraw their Principal and Interest. Notably Interest Rates are a function of Utilization thus this is closely linked to Interest rate risk.

In each of these, risk will be greater for lending against lower-liquidity collateral. In practice we will focus on top staking derivative protocols and will not price in Slashing Risk to our valuation algorithms.

Addressing Interest Rate Risk and Liquidity Risk - the Duration Factor

Pricing the Aggregate Borrow and Discount Rate for Instant Token Unstake

Our on-chain oracle will thus calculate the following figures to a high degree of accuracy to ensure liquidity providers are appropriately compensated for Instant Unstake purchases:

Instant Unstake Swap Rate Projections

Data and chart source: Parallel calculations

Establishing DF Value For ETH Staking Derivatives

It is difficult to estimate the total term of loans in the P2Pool lending model and as such we need to look beyond pure DeFi to estimate average loan duration. According to on-chain data for P2P NFT lending, lenders and borrowers on average agree to a 30-day average lending term for P2P NFT loans. But in this case the quality and liquidity of collateral is ETH staking positions—the more conservative number makes sense here.

Setting Protocol Insurance Reserve and Supplier Rates

We can thus calculate the share of each Instant Unstake of NFT discount which goes to the supplier and which share goes to the protocol insurance reserve.

We can thus calculate the share of each token sale which goes not to the supplier pool but to the insurance protocol reserve as indicated below. The area under 1.000 indicates the share which goes to the Protocol Reserve:

Last updated