Optimal risk-aware interest rates for decentralized lending protocols

Bastien Baude (), Damien Challet () and Ioane Muni Toke
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Bastien Baude: MICS - Mathématiques et Informatique pour la Complexité et les Systèmes - CentraleSupélec - Université Paris-Saclay, FiQuant - Chaire de finance quantitative - MICS - Mathématiques et Informatique pour la Complexité et les Systèmes - CentraleSupélec - Université Paris-Saclay
Damien Challet: MICS - Mathématiques et Informatique pour la Complexité et les Systèmes - CentraleSupélec - Université Paris-Saclay, FiQuant - Chaire de finance quantitative - MICS - Mathématiques et Informatique pour la Complexité et les Systèmes - CentraleSupélec - Université Paris-Saclay
Ioane Muni Toke: MICS - Mathématiques et Informatique pour la Complexité et les Systèmes - CentraleSupélec - Université Paris-Saclay, FiQuant - Chaire de finance quantitative - MICS - Mathématiques et Informatique pour la Complexité et les Systèmes - CentraleSupélec - Université Paris-Saclay

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Abstract: Decentralized lending protocols within the decentralized finance ecosystem enable the lending and borrowing of crypto-assets without relying on traditional intermediaries. Interest rates in these protocols are set algorithmically and fluctuate according to the supply and demand for liquidity. In this study, we propose an agent-based model tailored to a decentralized lending protocol and determine the optimal interest rate model. When the responses of the agents are linear with respect to the interest rate, the optimal solution is derived from a system of Riccati-type ODEs. For nonlinear behaviors, we propose a Monte-Carlo estimator, coupled with deep learning techniques, to approximate the optimal solution. Finally, after calibrating the model using block-by-block data, we conduct a risk-adjusted profit and loss analysis of the liquidity pool under industry-standard interest rate models and benchmark them against the optimal interest rate model.

Keywords: decentralized finance; decentralized lending protocol; interest rates; liquidity risk; market microstructure; stochastic optimal control; deep learning (search for similar items in EconPapers)
Date: 2025-02-28
Note: View the original document on HAL open archive server: https://hal.science/hal-04971758v1
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