Control parameters
Protocol net profit is equal to the sum of fees generated by Borrowers (through interest, borrow fees and liquidations) minus the losses they incur to the protocol (through unprofitable liquidations). Borrowers in the highest tiered vaults pose the greatest risk to profitability, since liquidations there may lead to the accumulation of toxic debt in the system (i.e. debt which is not recoverable by liquidating the underlying collateral).
Risk control parameters
To manage and optimize profitability, the ARCx Credit system provides a number of unique control parameters. Through understanding, monitoring and fine-tuning these parameters, ARCx Credit will deliver sustainable net profit across its loan book.
| Control parameter | Description |
|---|---|
Maximum LTV offered in each vault | The primary way in which ARCx Credit exposes itself and its lenders to risk of unprofitable liquidations. Based on our analysis, we are comfortable launching with 100% max-LTV on ETH collateral for borrowers with a DeFi Credit Score of 999. |
Fees charged to borrowers | The fees we generate through interest rates, loan instantiations and liquidations. Fees are earned from borrowers as they build their DeFi Credit Score, and may be used to cover losses born from unprofitable liquidations. At present, the interest rate is set by ARCx Credit, but in future this will be set dynamically based on supply / demand. |
Score impact for borrowing (or the time required to improve your DeFi Credit Score) | The length of time required for a borrower to build their DeFi Credit Score will influence the amount of fees we generate from an individual borrower before a liquidation might result in the accumulation of toxic debt |
Score impact for liquidations | The impact on a borrower’s DeFi Credit Score in the event of a liquidation. The impact should be configured such that it appropriately disincentivize liquidations, primarily by the opportunity cost of losing access to improved capital efficiency and the time required to rebuild the Score. |
Shape and configuration of the Rewards Curve | The shape and configuration of the Rewards Curve that determines the Daily Score Reward. This includes defining the "optimal" borrow usage point (influencing where borrowers sit to grow their Scores), and the shape of the curve itself (e.g. providing more flexibility to borrowers in determining their own optimal position without unnecessarily penalizing them with a lower Daily Score Reward) |
Credit limit imposed on each vault | The maximum amount of debt a borrower can access from a given vault, regardless of their collateral deposited. This prevents debt concentration risk in higher tiered vaults, and limits the quantum of losses on liquidation. Credit limits may be static (i.e. the same for all borrowers) or dynamic (i.e. based on how much debt a borrower has used in other vaults). |
Incentive model
The design of ARCx Credit and the DeFi Credit Score aim to incentivize responsible borrowing behavior. This is based on two unique factors:
The time and effort required to build to a high DeFi Credit Score (which would be a sunk cost if a wallet is abandoned after liquidation)
The quantifiable benefit that a borrower receives from continued access to higher-tiered vaults (i.e. the capital efficiency gained)
Since the growth of the DeFi Credit Score is explicitly tied to responsible borrowing behavior, users who want access to improved capital efficiency will be incentivized to borrow responsibly. Conversely, if the expected benefits of continued access to improved capital efficiency exceed the penalty for liquidation and the time and effort required to rebuild a Score, then borrowers will be incentivized to avoid liquidation.
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