Introducing Mars Protocol’s Risk Framework

  1. Assessing the riskiness of assets to be added to the platform; and
  2. Based on that assessment, setting the risk parameters for those assets.

Risk categories and measured variables

  • Market Risk: Measures the liquidity and volatility of the asset.
  • Smart Contract (SC) Risk: Measures the riskiness of the asset at the technical layer.
  • Counterparty (CP) Risk: Measures the centralization risk of the asset.
  • Maximum intraday drawdown: Maximum price change (from high to low) in a trading day over the last 365 days.
  • Volatility: Standard deviation of the logarithmic daily returns over the last 90 days.
  • 24hr volume: Average 24hr volume over the last 90 days.
  • Worst 7-day volume: Minimum 7-day average 24hr volume over the last 90 days.
  • Time since launch.
  • Honey pot: Daily sum of the project’s Total Value Locked (TVL) since launch. For standardization purposes, this value is divided by $365B ($1B per day for 365 days) to arrive at the Honey Pot coefficient.
  • Audits quality (Qualitative): Thoroughness and quality of audits performed on the project.
  • Quality of smart contracts (Qualitative): Measures the overall riskiness of the smart contracts. Evaluates the use of best practices, the thoroughness of the tests and the documentation, among other factors.
  • Team (Qualitative): Evaluates the reputation and integrity of the team behind the project.
  • Key contracts centralization (Qualitative): Measures the level of centralization of the most important contracts of the protocol.

Scoring Methodology

Example of a Market Risk Score Calculation

  • Intraday worst drawdown: A
  • Volatility: B
  • 24hr volume: C
  • Worst 7d volume: B

Risk Parameters

  • Loan-to-Value (LTV): Determines the maximum amount a user can borrow with a certain collateral. For example, if the LTV of an asset is 50%, a user who deposits 1,000 UST worth of that asset will be able to borrow up to 500 UST worth of any asset available on the platform. Given that a user can deposit multiple assets as collateral, the total LTV for a user can be calculated as follows:
  • Liquidation Threshold: Determines the level at which a loan is considered to be undercollateralized and can be liquidated. For example, if the Liquidation Threshold of a position is 70% and the value of the borrowed assets for that position increases to over 70% of the value of the collateral, the position can be liquidated. The liquidation threshold will always be higher than the LTV for every asset. This serves as a margin of safety for borrowers. The Liquidation Threshold per user can be calculated as follows:
  • Liquidation Bonus: Determines the bonus the liquidator receives when it liquidates a position. This bonus is paid from the collateral of the user that gets liquidated. For example, if the liquidation bonus is 15%, liquidators receive an additional 15% of the borrower’s collateral for every unit of debt repaid.
  • Optimal utilization: Determines the optimal ratio of borrowed vs. deposited assets for a given money market. For example, if the optimal utilization of a market is 80%, then at the optimal utilization level the amount of assets borrowed from that market should be 80% of the assets deposited into that market.
  • Exposure Limit: Mars will set a deposit limit to certain assets based on their risk profile. This cap will serve as a protection mechanism that allows newer (and potentially riskier) assets to be added to the platform without sacrificing the overall integrity of the system. Whenever an asset hits its exposure limit, its LTV automatically becomes 0. This means that at that point the asset won’t be accepted any longer as collateral within Mars, thus limiting the exposure of the platform to that asset.
  • Collateral (Binary): Indicates whether an asset can be used as collateral within the platform. Some assets that fall into a specific risk profile may be allowed to be deposited in the platform and made available for borrowing, but they wouldn’t be usable as collateral.
  • Kp (controller proportional term): Defines how quickly the interest rate reacts to changes in utilization. This parameter varies from market to market depending on two main factors — the overall risk rating and the responsiveness of the asset. Two values of Kp need to be defined: Kp1 for normal conditions and Kp2 to be used in extreme conditions. Normal conditions refer to situations where utilization is within a 20 percentage point range from the optimal utilization. In situations where that’s not the case, Kp2 will be used such that interest rates adjust more aggressively.

LTV, Liquidation Threshold and Liquidation Bonus

Conclusion

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