Adaptive Money Market Interest Rate Strategy Utilizing Control Theory

ArXiv ID: 2407.10426 “View on arXiv”

Authors: Unknown

Abstract

Decentralized Finance (DeFi) money markets have seen explosive growth in recent years, with billions of dollars borrowed in various cryptocurrency assets. Key to the safety of money markets is the implementation of interest rates that determine the cost of borrowing, and govern counterparty exposure and return. In traditional markets, interest rates are set by risk managers, portfolio managers, the Federal Reserve, and a myriad of other sources depending on the market function. DeFi enables an algorithmic approach that typically relies on interest rates being directly dependent on market utilization. The benefit of algorithmic interest rate management is the system’s continual response to market behaviors in real time, and thus an inherent ability to mitigate risks on behalf of protocols and users. These interest rate strategies target an optimal utilization based on the protocol’s risk threshold, but historically lack the ability to compensate for excessive or diminished utilization over time. This research investigates contemporary DeFi interest rate management strategies and their limitations. Furthermore, this paper introduces a time-weighted approach to interest rate management that implements a Proportional-Integral-Derivative (PID) control system to constantly adapt to market utilization patterns, addressing observed limitations.

Keywords: DeFi Interest Rates, PID Control, Money Markets, Utilization Rate, Algorithmic Strategy, Cryptocurrency

Complexity vs Empirical Score

• Math Complexity: 7.0/10
• Empirical Rigor: 3.0/10
• Quadrant: Lab Rats
• Why: The paper introduces a novel PID control theory framework for DeFi interest rates, which involves moderately advanced control theory concepts, but provides only a conceptual model without backtests, code, or historical simulation results.

  flowchart TD
    A["Research Goal:<br>Develop Adaptive DeFi Interest Rate Strategy"] --> B["Analyze Existing Strategies<br>e.g., Utilization-Based"]
    B --> C{"Identified Limitations<br>Lack of time-weighted adaptation?"}
    C -- Yes --> D["Design Methodology:<br>Integrate PID Control System"]
    C -- No --> E["Refine Existing Strategy"]
    D --> F["Data & Inputs:<br>Market Utilization Rate over Time"]
    F --> G["Computational Process:<br>PID Controller Calculation<br>Proportional + Integral + Derivative"]
    G --> H["Key Outcome:<br>Adaptive Interest Rates<br>Optimized for Stability & Risk"]
    E --> H