A proposal to adjust one (1) risk parameter for two (2) Compound V3 assets.
|Parameter||Current Value||Recommended Value|
|COMP Liquidation Factor||88%||83%|
|WBTC Liquidation Factor||95%||93%|
Updates to the Liquidation Factors allow the Compound protocol to ensure it’s solvency during extreme market conditions. By decreasing these parameters, this increases the incentive for liquidators to take collateral off the protocol’s books as it accumulates.
Gauntlet’s simulation engine has ingested the latest market and liquidity data. These parameter updates are a continuation of Gauntlet’s regular parameter recommendations as part of Dynamic Risk Parameters.
In certain extreme market conditions - Compound III’s liquidation mechanism can be stuck with insolvent collateral. If liquidators can profit from swapping after acquiring collateral from Compound III at a discount, they will acquire the assets, and the protocol can avoid holding the collaterals over time. Thus, liquidity and liquidation factor are two key exogenous variables for successful liquidations (liquidators call absorb, buying from Compound III and swapping them out). While we cannot directly control the former, increasing liquidation incentives can reduce protocol insolvency risk. Gauntlet’s agent-based simulations use a wide array of varied input data that changes on a daily basis (including but not limited to user positions, asset volatility, asset correlation, asset collateral usage, DEX/CEX liquidity, trading volume, expected market impact of trades, liquidator behavior). Our simulations tease out complex relationships between these inputs that cannot be simply expressed as heuristics.
Based on Gauntlet’s simulation results as of 2022-12-27, decreasing COMP liquidation factor from 88% to 83% reduces Value at Risk (VaR) for COMP from $5.5m to $5m, a ~9% reduction. Decreasing WBTC liquidation factor from 95% to 93% reduces its VaR from $5.9m to $4.9m, a ~17% reduction. Given the current supply amount of COMP and WBTC in the market, and the implied VaR size (38.5% and 8.7% respectively for COMP and WBTC), we want to proactively propose reducing liquidation factor as a prevention for potential disastrous market events.
We’d note that given that these parameter changes are for the liquidation incentive, there is not a meaningful impact on capital efficiency.
The below heatmap shows the average % net insolvent COMP under different market scenarios. When the market has 22x volatility, decreasing liquidation factor from 88% to 83% drops the insolvency percentage from 11.86% to 9.73%, and when the market has 16.75x volatility, from 3.47% to 2.99%.
The below heatmap shows the average % net insolvent WBTC under different market scenarios. When the market has 22x volatility, decreasing liquidation factor from 95% to 93% drops the insolvency percentage from 2.04% to 1.33%, and when the market has 16.75x volatility, from 0.29% to 0.11%.
As mentioned, these changes do increase the penalty paid by users when they are liquidated. This is to increase the premium paid to liquidators who take on the risk of selling their collateral, and can offset costs like slippage. This is not positive for the borrow user experience, but is likely justified by the reduction in VaR. Looking at COMP as the example:
- Currently there is a 12% penalty paid when useres are liquidated
- 6% of that goes to Compound reserves, 6% of that goes to liquidators
- This proposal changes that to 17%, 8.5% and 8.5% respectively
Another option here would be to reduce the
StoreFrontPriceFactor (SFPF) which determines the split between Compound and liquidators. This would allow the protocol to lower VaR without increasing the liquidation penalty as much (or even at all)l.
This would end up negatively affecting the protocol reserve growth over time, so there are real tradeoffs here. We have not suggested any changes to this parameter yet, but if people are worried about the liquidation penalty becoming to high, we could investigate the options we have with SFPF.
We welcome community feedback here. We plan to go to proposal on-chain on 1/2/23 or as soon as we are able to incorporate any blocking feedback
We’d note that VaR here refers to the amount of collateral that has been absorbed by Comet but not purchased by liquidators. In other words, the VaR calculation refers to the value of absorbed collateral that is sitting on Comet’s balance sheet and is subject to pricing risk. This definition of VaR is slightly different from the definition of VaR for Compound V2 in order to align specifically with Comet’s new liquidation mechanism.
Gauntlet launched an insolvency refund for Compound that contains a portion of our payment stream that can be clawed back in the event of insolvencies due to market risk. Since our last recommendation there have been no new insolvencies in Compound, Gauntlet’s Insolvency Refund vault is still live and can be seen here 0x7667095Caa12b79fCa489ff6E2198Ca01fDAe057
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