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Defi ecosystem is composed of many components, and the risk of a single component may affect the entire system, so we need to consider the risk composition of the Defi system. Currency is the core of the JustLend DAO protocol. This document will focus on the risk assessment of currency in the JustLend DAO protocol. The main risk factors are smart contracts, trading opponents and currency markets. This document aims to contribute to a higher standard of risk in DeFi.
Users can deposit and lend digital currency in the JustLend DAO protocol, and depositors are compensated with interest. Each loan in the agreement has collateral as a guarantee. The borrower deposits the collateral to lend the loan. Generally, the collateral currency and the loan currency are different. The following conditions need to be considered when adding new currency support to the agreement :
- Every time a new currency is added as collateral to the JustLend DAO protocol, it increases the risk of the protocol going bankrupt. From a financial perspective, the assets of the JustLend DAO protocol are the collateral, and the liabilities are the loan amount. Assets and liabilities are often in different base currencies, and both loans and collateral contain stablecoins, which means the protocol is vulnerable to failures in the collateral tokens themselves, as well as market volatility.
- Centralized collateral tokens will expose the protocol to centralization risks, and the single point of failure risk of the base currency will bring systemic risks to the JustLend DAO protocol.
- Currency used only for deposits and loans generally does not bring high risk to the protocol, the lent tokens are liabilities of the JustLend DAO protocol, and the collateral is the assets held by the protocol. To ensure the health of the protocol, these assets must remain larger than debt.
- Diversified currencies are supported in the loan pool of the JustLend DAO protocol, which can reduce risks through diversified returns.
When adding new currencies to the protocol, careful consideration is required, and the basic rule is to ensure that the value of adding new currencies outweighs the risks, so we only consider currencies with high value and are from important communities.
The Defi ecosystem is usually composed of individual components that may be part of other systems, which enables the JustLend DAO protocol to connect with other ecosystems, which also makes the protocol potentially affected by other systems. The currency used in the protocol is the key to affecting the protocol, especially the currency used as collateral. To ensure that the currency supported by the protocol has reasonable risk, we will evaluate a currency from three levels.
First, we look at the smart contract security of the currency and the counterparty of the currency. If the risks in these two aspects are too high, we will refuse to accept the such currency, and the currency that has been accepted will also be disqualified as collateral. Then, we analyze the market risk. Of course, this part of the risk can be controlled by the protocol through the risk parameter parameters.
The main consideration of smart contract risk is the technical security of the underlying code of the token. If there is a security risk in the smart contract of a collateral currency supported by JustLend DAO, the collateral will be affected, thereby threatening the solvency of the protocol.
Smart contract hacks have caused millions of dollars in losses, so currencies with higher smart contract risks cannot be integrated into the protocol, and the token’s smart contract must pass a rigorous review before the token can be accepted. For the risks posed by smart contracts, sometimes bug bounties can help, but not completely. We evaluate the maturity of token smart contracts based on metrics such as creation time, number of transactions, and audit reports.
Assessing counterparty risk is primarily an assessment of how the currency is managed and who manages it. We have seen that some token management is too centralized, which brings an extremely high risk to the token. We will consider the number of token managers, the number of token holders, and the trust of the token team. Currencies with high counterparty risk are not eligible as collateral tokens.
Market risk is related to market size and token price fluctuations, and the market risk of collateral tokens brings a lot of risk to the JustLend DAO protocol. If the value of the collateral falls, the liquidation threshold may be reached and liquidation begins, then the market needs to have sufficient trading volume to fully liquidate these debts, and a large amount of liquidation will also put a lot of selling pressure on the collateral tokens in the market. Thereby, further causing the value of the collateral to fall.
Cryptocurrencies can be subject to wild swings in the market, often seeing prices fluctuate by 30% within a week or month. In order to protect users when the price of tokens rises, the JustLend DAO protocol may adjust parameters to prevent the risks that users' new actions may bring. The JustLend DAO protocol has a set of parameters to control the risk of price fluctuations, and the protocol will determine the collateralization rate based on price volatility.
We also consider the market size of the token. Generally, we use the market value of the token to measure the market size of a token.
When the borrower's outstanding loan value exceeds its safe collateral rate, the JustLend DAO protocol will automatically initiate liquidation to eliminate the risk of the protocol and ensure that funds withdrawal and lending always have excess cash ability, while protecting the depositor's capital risk. Therefore, there is a need to calculate the asset value of the borrower's collateral and the value of the borrower's assets in real-time. Therefore, it is necessary to obtain the price information of various assets in real time. The JustLend DAO protocol uses the Winlink decentralized oracle for price feeds, and at the same time adopts a "smoothing mechanism" to avoid risks and avoid the risks brought by short-term large price fluctuations to the protocol.