In Practice
Market Risk Assessment Checklist
To effectively understand and assess market risks in a DeFi protocol, participants should consider the following checklist:
Market Risk Assessment Report Availability:
Confirm whether the DeFi protocol provides a comprehensive market risk assessment report. This report is crucial for understanding the risks associated with participating in the protocol.
Third-Party Assessment:
Determine if the market risk assessment was conducted by an independent third party. Independent assessments can provide an unbiased view of the risks.
If the assessment was done by a third party, conduct due diligence on the firm that performed the market assessment. Verify their credentials, reputation, and experience in the field of DeFi and risk assessment.
In-House Assessment:
If the assessment was done in-house, identify the team or individuals who conducted it. Review their profiles, qualifications, and experience to assess their capability in accurately identifying and assessing market risks.
Content and Scope of the Market Risk Assessment:
The market risk assessment should, at a minimum, include:
An analysis of price volatility risks.
Liquidity risks and how they affect the protocol's operations.
Counterparty risks, considering the decentralized nature of DeFi.
Systemic risks that could arise from interconnectedness with other protocols and the broader DeFi ecosystem.
Strategies for managing and mitigating these risks, including specific mechanisms like liquidation thresholds, safety modules, and any insurance or reserve funds.
Historical data or case studies demonstrating how the protocol has responded to past market stress events.
Simulated stress testing across historical and hypothetical volatility scenarios
Assessment of liquidation mechanisms and liquidator incentives
Analysis of cascade risks across correlated assets
Evaluation of backstops like insurance funds
Actionable recommendations for risk mitigation
Ongoing Risk Monitoring/Risk Dashboard Availability:
Check if the DeFi protocol offers a risk dashboard that provides recently updated or real-time data to monitor various market risks. Such a dashboard can offer insights into current risk levels, trends, and the effectiveness of risk mitigation strategies.
Does it track metrics like:
Collateralization ratios
Liquidation buffers
Asset correlations
Insurance fund balances
Are there warning triggers tied to pre-defined risk thresholds?
Is the dashboard transparently displayed or auditable?
Upgrade Governance
Parameter Governance: Review processes for changing risk parameters/ Review governance processes that guide risk parameter changes
Prioritization Cadence: Assess pace of implementing model recommendations
Architecture Communication: Clarity provided on future stability upgrades/Check that future upgrades to stabilize architecture are clearly communicated
Explore
Aave Market Risk Assessment
Uniswap Market Risk Assessment
https://risk.gauntlet.xyz/protocols/aave
https://docs.aave.com/risk/v/aave-v2/audits/gauntlet
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