B.Protocol’s Risk Level Index in Action: Validating Gearbox v3 Risk Parameters
Introduction
B.Protocol’s SmartLTV formula is a smart contract that calculates recommended LTV ratios based on quantitative risk-related data inputs. The formula includes a risk level factor (r), a single constant parameter that aims to represent all the implicit and explicit assumptions made within any risk assessment framework through a single numeric value. The Risk Level Index tracks changes in the risk factor levels over time to present the ongoing risk exposure users of a specific market bear.
As part of the engagement with Gearbox, RiskDAO, our research arm, used the SmartLTV formula and the Risk Level Index to validate and confirm the risk parameters suggested by community members for Gearbox v3 launch phase.
In this post we will elaborate on the different data inputs the SmartLTV formula gathers for computing the LTV, and how the Risk Level Index was used to compare the risk exposure of Gearbox users to other DeFi lending markets, e.g. Compound v3.
The results show that the proposed risk parameters are currently within the norm, and adhere to similar risk levels that are used in Compound v3. Notably, some assets experienced an irregular risk level in the last 6 months. Hence, it is recommended to closely monitor changes in their risk levels and take action accordingly.
The risk level will soon be available on-chain for smart contracts to interact with. It can be used to automate economic risk management decision-making or to guard the operation of human risk committees by enforcing accepted risk ranges in the code.
Calculating LTVs with the SmartLTV formula
SmartLTV is a smart contract formula that offers a simplified yet robust method for LTV ratio calculations based on quantitative data, minimizing the human factor in the process.
The formula takes into account the following market parameters:
- σ is the price volatility between the collateral and debt asset (normalized to the base asset price).
- β is the liquidation bonus.
- ℓ is the available dex liquidity with a slippage of β.
- d is the debt cap of the borrowable asset.
- r is a risk level factor. The higher r is, the odds for insolvency increase.
If the LTV is set, one can isolate the risk factor and use it to compare risk exposure levels of different markets, creating a risk level index.
The Risk Level Index
The Risk Level Index introduces a standard for assessing economic risk in DeFi lending markets. It functions as a benchmark, quantifying risk exposure in lending markets by aggregating diverse market metrics such as DEX liquidity and asset price volatility, together with platform-specific parameters such as liquidation bonus and debt caps, into a single numerical value. This index serves as a comparison tool, allowing users to assess and compare risk levels across different lending markets. Additionally, it provides historical tracking, enabling stakeholders to monitor changes in risk exposure over time. The standardized measurement simplifies risk assessment and historical analysis for a wide range of DeFi lending participants.
We have recently published the first Risk Level Index for Compound v3 Ethereum markets, tracking and comparing the risk exposure of users in these markets over time.
The weighted average risk level of Compound v3 markets has fluctuated around 8 for the last 3 months. Some specific assets, such as COMP and ETH on the USDC market, hold higher risk levels of up to 16, indicating a more bullish approach by Compound DAO towards these specific markets.
Validating Gearbox v3 risk parameters
Using the SmartLTV formula and the Risk Level Index, we calculated the risk levels for each of the suggested markets for Gearbox v3 launch phase and compared it to Compound v3 to see if there were any outliers.
We used the LT, the borrow limit cap, and the liquidation bonus that were suggested by the Gearbox community together with the volatility and liquidity of each asset as they are being calculated by B.Protocol’s Risk Oracle. With these data inputs, we calculated the risk factor and created a Risk Level Index for Gearbox v3’s suggested launch parameters.
Below we present the results for the USDC pool for Tier 2 and Tier 3 assets. Tier 1 assets were already included in Gearbox v2 and are not covered in this analysis.
We used a liquidation fee (β) of 5.5%, derived from the 4% liquidation bonus taken by the liquidator and 1.5% platform fee. Debt Caps (Limit) and Liquidation Threshold (LT) are as suggested by Gearbox community members -
The results show that assets are currently within the norm, and adhere to similar risk levels that are used in Compound v3. Some assets, marked in the table with (*) experienced irregular risk levels in the last 6 months. Hence, it is recommended to closely monitor the changes in the risk level and take action accordingly.
The Risk Level Index can be used also to compare the risk exposure between different LT ratios before setting or adjusting the different risk parameters, and it will soon be available on-chain for smart contracts to interact with. It could then be used to automate decision-making or to guard the manual operations of risk committees by enforcing an accepted risk level range in the code.
Below are the Risk Level Index graphs for CVX, CRV, and MKR showing the current suggested LTV (72.5% for CVX & CRV, 82.5% for MKR) along with other LTV ratios, while keeping the same Limit (e.g. Supply Cap) and the same liquidation fees (e.g. Bonus). These graphs can be used to compare how different LTVs affect the risk level of a market -
About B.Protocol
B.Protocol has been building open-source protocols and infrastructure for risk mitigation and assessment for the DeFi ecosystem since 2020. Through our research arm, RiskDAO, and its novel risk framework, we have supported over a dozen DeFi protocols with risk analysis, research, audits, and monitoring. Our Risk Oracle, together with the SmartLTV formula, and the Risk Level Index automate the process of setting risk parameters for lending platforms in a transparent way, building the next generation of DeFi risk management infrastructure.
