ETH Borrow Rate’s Impact on Interest Compounding ETH

Interest Compounding ETH (icETH), the leading leveraged liquid staking rewards token by TVL, has recently outperformed both ETH and stETH. As we saw with the deviation between the stETH/ETH price earlier this year, Set’s battle-tested infrastructure and automated safeguards minimize the risk of maintaining a collateralized debt position in Aave.

How ETH Borrow Rate Affects icETH

In the lead-up to the Merge, Aave and other ETH lending protocols are experiencing a significant increase in ETH borrowing. Market demand for ETH is causing an overall rise in borrowing rates. While rates earlier in August hovered around 1.8%, they’ve gone up ~4x to 7.38% at the time of writing.

The recursive borrowing strategy tokenized in icETH creates a positive APY when the stETH rewards rate exceeds the Aave ETH borrow rate. On August 31st, the Aave ETH borrow rate eclipsed the stETH rewards rate for the first time, resulting in a negative APY for icETH.

Over the past two months, icETH has outperformed both ETH and stETH.

Holders are still earning positive interest on icETH relative to ETH, but for the time being, interest earned is less than holding stETH.

When Will A Positive APY Return?

The APY of icETH vs. ETH and stETH is impacted by the supply/demand of ETH on the Aave market. The APY of icETH can bounce between positive and negative rates until the leveraged stETH rewards rate consistently exceeds the borrowing rate of ETH.

One event that could potentially stabilize a positive APY is the Ethereum Merge, which is expected to occur on September 13th, 2022. Debt positions on Aave related to ETH “fork farming” will need to be repaid and will likely occur post-Merge, as borrowers won’t want to pay interest in perpetuity once they’ve claimed and liquidated any ETH PoW.

Alternatively, the borrow rate in Aave could decrease before the Merge, though this is unlikely. There is an active proposal on the Aave forum to pause new ETH borrowing, which would stabilize the borrow rate and prevent new ETH debt positions from being opened. If this proposal is implemented and borrowers repay ETH, the borrow rate would theoretically decrease (assuming ETH supply remained constant).

Proactive Steps Index Coop Is Taking

Until the market and ETH borrowing rate stabilize, Index Coop will continue to take proactive measures to ensure the security of icETH token holders:

Suspending the icETH streaming fee

• Until further notice, Index Coop has dropped the icETH streaming fee to 0%.

Strategy tokens with automated safeguards

• Continued use of Automated Leverage Management - our strategy tokens and smart contracts are coded to ensure that market volatility does not lead to the liquidation of funds. This includes the ability to safely de-lever.
• The risk automation in place for icETH will continue to dynamically de-lever if the stETH discount increases relative to ETH and mitigate liquidation risk

Provide transparent and timely information

• We will continue to monitor potential risks and communicate transparently with our token holders

What’s Next?

The Index Coop team will continue closely monitoring the ETH borrowing rate and its impact on icETH returns. Index Coop, icETH smart contracts, and partners in the ecosystem will continue to adapt to future market challenges.

If you’re looking to buy/sell/redeem icETH, visit our Index Coop app or the Tokensets website.

Have questions,  just want a better understanding of icETH or recent market conditions? Reach out to us in our #iceth Discord channel.

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