Aave's Risk Framework has been released! Take a look at the docs for a comprehensive analysis of the fundamental risks of the protocol and the processes in place to mitigate them. Credits to our Risk Manager @A_BertoG 👻https://t.co/M9T19iEsGi
— Aave (@AaveAave) April 23, 2020
In light of the protocol’s rapid growth in the past months, Aave is quickly establishing itself as a market leader when it comes to lending and borrowing top cryptocurrencies. With nearly 20 supported assets at the time of writing, the protocol’s diversity providers a strong capacity for people to deposit top assets like LINK and SNX to earn extra borrowing capacity on their favorite holdings.
For those unfamiliar with Aave, the protocol also offers Stable APR’s on borrowing and the ability for uses to conduct Flash Loans. This Risk Framework comes at a crucial time as the team has suggested upgraded governance frameworks using the native token – LEND – in the coming weeks.
With that, here are some of the key takeaways from this framework and what other lending protocols can learn from it.
As with other Risk Frameworks, Aave’s follows a similar nature of rating assets on a scale from A+ (an asset with the lowest risk) to D- (the asset with the highest risk). By giving each asset a grade, it’s easy for others to see how different assets are evolving as it relates to risk – something we’ve seen offered by projects like DeFi Score and Inspect in recent weeks.
As for the Risk Factors themselves, Aave’s risk team examines:
- Smart Contract Risk – Considers the number of audits, maturity, and quantity of transactions that have passed through an asset’s underlying contract.
- Counter-Party Risk – The degree of centralization an asset has using governance and custody as a reference.
- Market Risk – Market cap, price volatility, and liquidity risk. Can an asset sustain market fluctuations or is it highly volatile and subject to liquidations?
Let’s look at how these factors have played into the assets currently listed on the platform.
The biggest things to note here are while something like Dai is often touted as having the least centralization risk, it is the riskiest asset on Aave in terms of sheer maturity – specifically because Multi-Collateral Dai was only launched less than a year ago. This is not to say that Dai is “risky”, but does go to show that leveraging a suite of different metrics helps better establish the possible risks (and returns for bearing that risk) which come with it.
The new Risk Framework also offers Qualification Criteria, better demonstrating how different ratings are achieved.
Lastly, we’re able to see a Currency Risk Map, easily displaying the different ratings each supported asset has earned to date. It can be assumed that this list will be updated periodically as new assets are added and new metrics are updated to better reflect real-time ratings.
Across the board, it’s evident that ETH is the least risky asset on the platform. This is a perfect example of why it a) is used most frequently for borrowing and b) has the lowest lending returns – both due to the amount of ETH being supplied and the fact that lending ETH is nowhere near as risky as something like bUSD (D+) or WBTC (C+).
Lastly, users can leverage the Risk Parameter dashboard to quickly view how different collateralization ratios stack up against one another relative to the ratings depicted above.
The Big Picture
While Risk Frameworks are nothing new, they are in fact one of the biggest and perhaps most important trends to hit DeFi in recent months. With more projects rolling out frameworks for evaluating risk, it’s only logical that these ratings will be more easily digestible by end-users – better informing their lending and borrowing experience to *hopefully* avoid interacting with assets which bear the largest degree of risk.
As DeFi continues to mature, we’re big believers that proper frameworks are crucial to the underlying growth of permissionless money markets. If anything is for sure, Aave’s introduction of such a diverse basket of assets suggest that there are likely to be many more in the near future, a strong signal for why one with a deeper knowledge of Ethereum-based assets would find value in the protocol over a sector leader like Compound or dYdX who currently offer less than 10 assets each.
In the meantime, we suggest staying up on all things Aave via their official Twitter as it’s sure to be an exciting month!
Until then, stay up on all things DeFi with our weekly newsletter!
Cooper is the Editor of DeFi Rate. He is an ambassador of Set Protocol and an active contributor to MetaCartel where he seeks to find emerging consumer-facing applications that propel the Ethereum ecosystem. He often works with projects as the Director of Fitzner Blockchain Consulting where he coauthors the weekly publication Token Tuesdays.
Like my writing? Drop me some gwei @ coopahtroopa.eth 😉