SmartLTV is Live on Mainnet — Automating Risk Management on Morpho Vaults
Intro
We are thrilled to announce that SmartLTV is live on Ethereum mainnet (in beta mode for now), creating the first ever fully automated and transparent economic risk management suite for DeFi lending platforms.
SmartLTV enables the first smart contract risk manager in DeFi lending, mitigating the biased human intervention, and separating objective risk-related data from subjective risk appetite, while adding the much-needed transparency and automation to DeFi’s economic risk management process.
Based on objective risk-related data feeds gathered by B.Protocol’s risk oracle, the SmartLTV risk formula calculates a Risk Level for each Morpho Blue market. We deployed a new smart contract as a MetaMorpho Allocator for our Flagship vaults. The contract is designed to automatically withdraw users’ funds from listed markets if they become too risky due to changes in market conditions, as indicated by a predefined risk level threshold.
In this post, we will recap what SmartLTV is, how we use it to calculate Risk Levels for Morpho Blue markets, and how the latest deployment on the MetaMorpho Flagship vaults sets a new benchmark for economic risk management in the DeFi lending ecosystem. But let’s start with the problem.
Minimizing the Human Factor
The promise of DeFi lies in its ethos of code-is-law, where neutral, self-executing applications on the blockchain minimize human intervention. However, one area where human bias still influences operations is in economic risk management, particularly in legacy DeFi lending platforms where risk parameters are still set and adjusted manually, relying on recommendations by 3rd party vendors and DAO votes.
This manual decision-making process suffers from several issues. Firstly, it is time-consuming, and in the fast-paced world of crypto, time sensitivity can expose platforms to unintended risks. Secondly, human bias can creep into decision-making, with influencers potentially manipulating decision-making processes to favor certain stake/token holders. Thirdly, the process is not self-executing, leaving room for decisions to be politicized or delayed due to governance issues within the protocol.
Another significant issue in the current DeFi lending landscape is the reliance on third-party risk management solutions, which often operate as opaque “black boxes.” These third parties are paid to set risk parameters, yet their interests and involvement in the process are not always clear. The danger here is that these third parties may prioritize business logic and growth strategies dictated by governance groups over effective risk management. This can result in risk parameters being set based on an unclear mixture of data driven risk assessment and business logic factors, potentially exposing lending platforms to unnecessary or at least non-transparent risks.
To address these issues, automated, decentralized, smart contract-based systems like SmartLTV offer a solution. By providing on-chain risk data and a simplified yet transparent risk framework, SmartLTV minimizes human intervention, reduces the risk of bias, and ensures that risk parameters are adjusted in a timely and consistent manner, aligning with the neutral ethos of DeFi. While not without its challenges, the transition to automated risk management is crucial for the integrity and stability of DeFi lending platforms.
SmartLTV — A Smart Contract Risk Manager on Duty
The SmartLTV formula has been used on the Flagship Vaults since MetaMorpho’s inception to set LLTVs for newly listed markets. Recently we have also launched the Morpho SmartLTV monitor that tracks the risk levels over time for each listed market.
Today we are happy to announce our next step towards building a fully automated, on-chain, economic risk manager. We have deployed a new smart contract as an Allocator on the Flagship Vaults. This smart contract is designed to withdraw users’ funds from any listed market, in case that market’s Risk Level has hit a predefined threshold which is considered too risky.
B.Protocol’s Risk Oracle fetches risk-related data that is being used by SmartLTV to calculate Risk Levels. This data is being digitally signed periodically and once the threshold risk level is hit, anyone can call the MetaMorpho Flagship Allocator to withdraw the funds from that market into safe ground (an Idle market or other safe markets).
As an extra safety measure, we deployed a new Gelato Network bot that periodically checks the risk level for each listed Morpho Blue market and automatically withdraws the funds in case the predefined risk level threshold is met.
This way, for the first time in DeFi, lenders get an automated risk manager safeguarding their funds based on objective and transparent on-chain data feeds. This step minimizes further the need of human intervention in the risk management process, relieving platforms from the human bias that comes along with it.
The SmartLTV is open source like all other development made by B.Protocol. Devs can find the SmartLTV Github repo here, and the documentation for it here.
Next steps would include putting the Risk Oracle data feeds on-chain in a verifiable way, enabling new use cases such as adjusting LTVs automatically and in a gradual way based on near-real-time changes in market conditions, implementing other risk management logic based on risk level dynamics and more.
SmartLTV Recap
Loan-To-Value (LTV) is a pivotal concept in maintaining the equilibrium between risk and accessibility. It’s a measure that ensures that lending platforms can provide loans securely without taking undue risk that might result in the accumulation of bad debt.
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 set by the lending platfrom.
- ℓ is the available DEX liquidity with a slippage of β.
- d is the debt cap of the borrowable asset as set by the lending platform.
- r is a risk level factor. The higher the r is, the odds for insolvency increase.
You can find the full whitepaper for the formula here.
If the LTV is set, one can isolate the risk factor and use it to compare risk level exposure of different markets, creating a risk level index.
Though crypto market conditions change rapidly, the LTV ratios set by lending platforms are not adjusted as frequently. This gap opens up a risk vertical that most users are not aware of. Once the LTV is set, changes in other parameters of the function (e.g. drop in DEX liquidity, or higher price volatility) will result in a change in the risk level. Tracking the historical values of r enables mapping the risk levels users are exposed to over time, comparing different markets’ risks, and even adjusting risk parameters more dynamically.
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 and SmartLTV formula automate the process of setting risk parameters for lending platforms in a transparent way, building the next generation of DeFi risk management infrastructure.
