Stability Fee behaves like the borrowing interest of H2O. They also act as a risk parameter designed to address the inherent risk in generating H2O against collateral in Defrost Vaults.
The Stability Fee for each Vault type can be different and changes as a result of the decisions of MELT token holders who govern the protocol. Stability Fee is calculated and can be only paid in H2O.
The Stability Fee is continuously compounding interest. The interest rate is called the Stability Fee Rate. When the Stability Fee Rate is set to 1%, for example, it means that after 12 months, the user will owe 1% on the principal.
The Stability Fee continuously accrues to the generated H2O balance of a user’s Vault. He/she is free to pay back H2O at any time they wish.
When a user is depositing collateral and minting H2O, the total debt he/she is undertaking includes the H2O principal generated and the Stability Fee continuously accruing. If part of the debt is repaid, the principal and outstanding Stability Fee will be paid back proportionately. The remaining amount of the debt, if any, will continue to accrue the Stability Fee.
Stability Fees are collected into the Reserve Pool continuously, when users making payments. H2O in the Reserve Pool is used to power the interest in the Savings Pool, and as the insurance for the protocol deficit in extreme market movements. Also, it can be distributed to staked MELT holders directly or for MELT market buy-backs.
The Stability Fee is a kind of policy tool to adjust the supply side of the H2O crypto-currency. Decreases in a Stability Fee, meaning lowering the cost/interest of borrowing, can incentivize the additional creation of H2O. Similarly, increasing Stability Fees can reduce H2O generation.
Initially, adjustment of the Stability Fee Rate will depend on a periodical process, whereby the Defrost Finance team will first evaluate and discuss public market data and proprietary data provided by market participants, and then make a judgement on whether an adjustment is necessary or not.
The long-term plan includes the implementation of the H2O Stability Fee Rate Governance Module, which includes deciding the Stability Fee Rate by governance voting by the MELT holders. The motivation behind this plan is to enable efficient responses to rapidly changing market conditions, and to avoid the over-use of the Defrost Finance team's dominance over the key economic parameters.