The documentation provided delves into the two primary risk components faced by Meso Finance: market risk and protocol risk management. Below is a detailed summary and analysis of these risks and the latest additions to the protocol risk management strategies.
Market Risk
Market risk involves the potential losses that can arise due to fluctuations in market conditions. These fluctuations can affect asset prices, interest rates, and overall market volatility, leading to possible financial losses for the protocol and its users.
Protocol Risk Management
Protocol risk management includes measures to mitigate risks specific to the protocol itself. These measures are crucial for maintaining the protocol's stability and preventing insolvency.
Market risks exert the most direct influence on risk parameters:
The liquidity, determined by on-chain liquidity and trading volume, is pivotal for the liquidation process. Measures to address this include caps and liquidation parameters, where lower liquidity prompts higher incentives.
Price volatility can detrimentally affect collateral, essential for covering liabilities and ensuring protocol solvency. Mitigation involves setting coverage levels required through Loan-to-Value ratios (LTV). Volatility also impacts liquidation, necessitating liquidators' margins to accommodate profit.
Market capitalization reflects market size, crucial for collateral liquidation. Although smaller market cap assets contain less risk, they often exhibit higher volatility due to their less mature nature. Higher market capitalization, among other factors, indicates a more developed ecosystem, translating to enhanced liquidity on exchanges and facilitating less impactful liquidations. Liquidation parameters are adjusted to mitigate high price impact liquidations for assets with smaller markets, thus correlating higher incentives with smaller market caps.
Risk Parameters Analysis
Meso Finance employs various advanced risk parameters and features to ensure robust protection against potential insolvency and to enhance the overall security of the protocol. These features include:
Liquidity Caps:
Supply Caps: Supply caps establish the maximum quantity of an asset that can be provided to the protocol. These caps serve to mitigate the protocol's exposure to riskier assets and safeguard against infinite minting exploits. They are optional parameters, with their value contingent upon the on-chain liquidity of the asset and the total volume of collateral assets in the pool.
Borrow Caps: Borrow caps set the upper limit on the amount of an asset that can be borrowed. They help prevent both traditional and flash borrowing of an asset that might be susceptible to price exploits, which could potentially lead to protocol insolvency. Similar to supply caps, borrow caps are optional parameters determined by the on-chain liquidity of the asset and the total volume of borrowed assets in the pool.
Efficient Mode:
Efficient Mode, or "e-Mode," categorizes assets that exhibit correlated prices, such as APT, USDT, and stAPT, into the same e-Mode category. This classification maximizes capital efficiency by enabling higher Loan-to-Value ratios (LTVs) when both the borrowed and collateral assets belong to the same e-Mode category.
Risk management parameters
Loan to Value (LTV) Ratio: The LTV ratio measures the amount of a loan relative to the value of the collateral securing the loan. It is expressed as a percentage.
Example: If the LTV is set at 75%, for every 1 APT worth of collateral, a borrower can take a loan of up to 0.75 APT worth of another currency.
How LTV Evolves:
Once a loan is issued, the LTV ratio can change due to fluctuations in the market value of the collateral.
If the value of the collateral increases, the LTV ratio decreases, indicating a safer loan (lower risk for the lender).
Conversely, if the value of the collateral decreases, the LTV ratio increases, indicating a riskier loan (higher risk for the lender).
Liquidation Threshold:
The liquidation threshold is the specific LTV percentage at which a loan is considered undercollateralized.
For example, a liquidation threshold of 80% means that if the LTV ratio of the loan exceeds 80%, the collateral is no longer sufficient to cover the loan, and liquidation processes may be initiated.
Example:
Initial LTV: 75%
Liquidation Threshold: 80%
The 5% delta acts as a cushion to absorb minor market volatility without immediately triggering liquidation.
Example Calculation in APT
Let's consider a wallet with three collateral assets:
Collateral 1:
Value in APT: 150 APT
Liquidation Threshold: 75%
Collateral 2:
Value in APT: 200 APT
Liquidation Threshold: 80%
Collateral 3:
Value in APT: 100 APT
Liquidation Threshold: 85%
Step-by-Step:
Values of Each Collateral Asset in APT:
Collateral 1: 150 APT
Collateral 2: 200 APT
Collateral 3: 100 APT
Multiply Each Value by its Liquidation Threshold:
Divide the Summed Products by the Total Collateral Value:
Liquidation Penalty:
Purpose: The liquidation penalty serves as a deterrent against allowing a loan to reach the liquidation threshold and compensates for the added risk and administrative costs involved in the liquidation process.
Impact on Collateral Sale: When collateral is liquidated, the liquidation penalty is added to the sale price. This means liquidators purchase the collateral at a slightly higher cost, and the borrower receives less from the collateral sale.
Example:
Loan amount: $10,000
Collateral value: $12,000
Liquidation penalty: 5%
If the collateral is liquidated, the penalty of 5% ($600) would be added to the sale price, and this amount is deducted from the proceeds returned to the borrower.
Liquidation Factor
Purpose: The liquidation factor helps in redistributing part of the liquidation penalty to support the ecosystem treasury. This can be used for various purposes, such as funding development, maintenance, and rewards for participants.
Share Distribution: The liquidation factor defines what share of the liquidation penalty goes to the collector contract.
Example:
Liquidation penalty: 5%
Liquidation factor: 20%
If the liquidation penalty is $600, and the liquidation factor is 20%, then $120 (20% of $600) is directed to the collector contract, and the remaining $480 is handled according to the platform's specific rules (e.g., paid to liquidators).
Health Factor : The Health Factor is a key metric in decentralized finance (DeFi) lending platforms that indicates the safety of a borrower's position. It's a ratio that represents the relationship between the value of the collateral deposited by the borrower and the amount of debt borrowed.
The Health Factor is typically calculated using the following formula:
Health Factor > 1: The position is considered safe, indicating that the value of the collateral exceeds the amount of debt borrowed. This means that even if the value of the collateral decreases, there is still enough collateral to cover the debt.
Health Factor = 1: The position is considered to be on the brink of being undercollateralized. In this scenario, the value of the collateral is equal to the amount of debt borrowed.
Health Factor < 1: The position is undercollateralized, indicating that the value of the collateral is insufficient to cover the amount of debt borrowed. This poses a risk to the lender, as there may not be enough collateral to recover the borrowed funds in the event of default.
Reserve Factor
The reserve factor designates a portion of the protocol's earnings to be directed towards a collector contract managed within the ecosystem treasury.
Here are the additions to the protocol risk management list in the future:
Isolation Mode Assets
Purpose: To list riskier assets with stringent borrowing restrictions.
Functionality:
Allows only one isolated asset to be used as collateral at a time.
Limits borrowing to isolated stablecoins.
Ensures that exposure to high-risk assets is controlled and does not affect the broader protocol.
Asset Reserve Caps
Purpose: To customize and enforce upper limits on the supply and borrowing of specific assets.
Functionality:
Prevents excessive risk exposure to individual assets.
Helps avoid issues such as infinite minting or manipulation of price oracles.
Provides a safeguard against systemic risks posed by specific assets.
The documentation provided examines the core risks associated with the protocol and outlines the specific procedures implemented to address them in greater depth.
