Latest news about Bitcoin and all cryptocurrencies. Your daily crypto news habit.
Using IntoTheBlock’s new product to mitigate risks in DeFi
We’re excited to announce the alpha release of IntoTheBlock’s newest product: an advanced set of risk management indicators for DeFi protocols. Dubbed the ITB Risk Radar, we aim to shed light on the most relevant economic factors that can put DeFi deposits at risk of losses. More details on the overarching vision behind the product launch can be found through the following piece from IntoTheBlock’s CEO, Jesus Rodriguez.
This product builds upon the strong growth of the ITB Quant product, where our institutional partners can generate yield on their assets with an automated risk management layer.
Within DeFi, we have decided to begin offering our risk management tools for lending protocols as these can be vulnerable to economic manipulation attacks draining depositors’ funds without them realizing. Some notable exploits like these include Avi Eisenberg’s infamous “highly profitable trading strategy”, where he managed to extract $115M from the Mango protocol prior to getting arrested, a $130M attack on Cream Finance by manipulating the value of an esoteric collateral or a $100M oracle manipulation attack that hit Compound back in 2020.
With this in mind, we are thrilled to work in collaboration with Benqi and Euler to release the Alpha version of the Risk Radar product. We hope that with this release we create greater transparency into the risks affecting lending protocols and help their teams and users alike in navigating these in the best possible way. Now let’s dive into some of the most relevant metrics within the ITB Risk Radar and how they can be used to manage risk in DeFi.
ITB Risk Radar in Action
Health Factor
A borrower’s health factor is one of the most important metrics to assess how close they are to being liquidated. If a borrower takes a loan for the maximum amount they can, they have a health factor of 1 and risk losing their collateral as soon as that drops below this threshold.
Via ITB’s Benqi Risk Radar
The distribution of health factors throughout a lending protocol provides an idea of the risk tolerance taken by its borrowers. If positions are concentrated with very low collateral factors it suggests a higher likelihood of liquidations taking place imminently. That being said, these are not necessarily negative for lending protocols unless liquidation opportunities are not profitable as we’ll discuss later.
It’s worth noting that there are two versions of this indicator: one specifically for recursive lending positions and another excluding these. Recursive lending strategies, also known as ‘looping’, deposit and borrow the same asset in order to obtain a higher share of token rewards being issued.
Since the value of the collateral and the loans of these positions move in tandem, they are less likely to be liquidated even if they have a health factor close to 1. For this reason recursive loans are tracked separately and have significantly lower ranges of values.
In both cases it’s worth keeping an eye if too many positions are approximating a health factor of 1 since if these drop below it but it’s no longer profitable to liquidate them then the protocol and its depositors risk ending with bad debt.
Liquidators Leaderboard
Liquidations perform the paramount service of rebalancing risky debt. When a borrower’s position drops below its liquidation threshold (and thus below a health factor of 1), liquidators step in to avoid their positions becoming undercollateralized.
They do so by claiming liquidated borrowers’ collateral at a discount– known as a liquidation bonus– and depositing the asset they borrowed in return. This prevents lenders from losing the assets they supplied and keeps the protocol’s books well balanced.
Given the importance of liquidators, it is worth tracking their performance over time.
Via ITB’s Benqi Risk Radar
Performing liquidations can be very profitable as exemplified by the top liquidator on Benqi earning over $1.6M. For this reason, it is also highly competitive and tends to concentrate within a few addresses.
Through this indicator we can monitor these addresses’ liquidations and even their holdings through the block explorer links. This can be valuable to understand their position and activity over time.
Blocks Elapsed to Complete Liquidations
A similar metric that adds further depth into the equation is the time liquidations take from the moment when they are available to the point when they are completed. This is the information reflected under the Blocks Elapsed to Complete Liquidations indicator.
Via ITB’s Euler Risk Radar (1Y left vs 3M right)
This data is helpful to understand the efficiency and reliability of liquidators. If liquidators are taking too long to liquidate positions, there is higher risk that the market may move in a disadvantageous direction where the protocol ends with bad debt. Therefore, it is typically best if liquidations occur within a reasonable timeframe.
In Euler’s case, there is a dutch auction mechanism in place where the liquidation bonus increases the more time that passes by. This may lead some liquidators to want to wait for this to grow, but also creates the chance for other liquidators to front-run those getting greedy and waiting for higher margins.
If we compare the number of blocks elapsed for liquidations to be settled on Euler over the past year (left picture above) vs during the past three months (right) we can see that liquidators are now waiting substantially less time. This can be considered an improvement in the reliability of liquidators and overall security of the protocol.
Whales Credit History
As many long-time crypto investors will know, it’s important to know what whales are doing to anticipate market trends. In this case, IntoTheBlock tracks the largest borrowers of lending protocols and shows their credit history over time. We define any address with 1% or more of the protocol’s debt as a “whale” under this metric.
Via ITB’s Euler Risk Radar
By monitoring large borrowers, one can keep track of the health of their positions and anticipate potential movements and their impact on the protocol. For instance, if a whale is close to liquidation and they haven’t repaid any debt, then it may be increasingly likely that they will get liquidated. Similarly, one can look if these whales hold any assets on their address which could be used to prevent getting liquidated.
This table is also helpful to understand the concentration of borrowing activity. If 90% of borrowing activity comes from one address, then the protocol is heavily dependent on that whale. On the other hand, if credit is more evenly distributed, it signals less reliance on whales for the protocol’s revenues and security.
Other Indicators + More to Come
In this piece we only covered the tip of the iceberg. There are 16 more metrics diving into the intricacies of Benqi and Euler. We also created extensive documentation for all of these, explaining what each indicator means and why it is important to consider for anyone looking to participate in DeFi.
These metrics can also be monitored in near real time through ITB’s Risk Radar API. Over the next few weeks we will be releasing the API functionality along with risk indicators for many other DeFi protocols. If you are interested in accessing these features make sure to contact us.
Finally, this is an alpha version of the Risk Radar release so we value feedback from our users and the broader DeFi community. If you have any suggestions on things that can be improved or other metrics you’d like to see feel free to let us know and we’ll consider your comments as we keep building out the product.
Introducing IntoTheBlock Risk Radar for Benqi & Euler was originally published in IntoTheBlock on Medium, where people are continuing the conversation by highlighting and responding to this story.
Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.