Compound V3 USDC Comet: Risk Parameter Updates 2022-12-28

Thanks, @rleshner, for your feedback to help move community discussion forward. We agree there are important tradeoffs for the community. From a risk management perspective, we aim to provide the community with more information on the risk side. Our simulations show a meaningful reduction in Value at Risk (VaR) from these parameter changes.

To clarify, higher liquidation bonus does not always reduce risk, because a bonus that is too high can push accounts closer to liquidation as well as increase the chances of liquidation cascades in certain tail events. As a result, we do not always recommend increasing liquidation bonus. Below is an example of simulation results that we conducted in our original Compound research. After the liquidation bonus reaches a certain point (around 5% in this specific example), the likelihood of insolvency (bad debt) increases (of course, for V3, it is not entirely apples-to-apples).

Thanks for providing this data here. For context, we do not measure slippage in a static way (we do not only consider current liquidity levels). This is because our simulations aim to measure risk in market stress periods (which can happen rapidly, as we have seen during Black Thursday). In tail market events, liquidity conditions can change dramatically. For example, in stress periods, there would be massive liquidations in the whole DeFi ecosystem, and liquidity can evaporate rapidly. Our model takes a more conservative assumption in case of such liquidity squeezes, and the Dashboard provides transparency for the results of the simulation under different volatility settings.

Given the risks of WBTC insolvency (making up a significant portion of VaR), we could either adjust liquidation penalty, liquidation threshold, or storefront price factor to reduce VaR.

  • We assume that Liquidation penalty is not as influential as liquidation threshold as a driver for user migration to V3.
  • Adjusting LT can either encourage risky behaviors or hinder user experience.
  • Given market conditions and recent volatility, our top priority is insolvency risk. Thus, we are relatively reluctant to recommend adjusting the storefront price factor right now, but it is a top consideration should reserves grow or if market conditions improve.

Of course, there are strategic considerations here as well. For example, the community may decide to heavily focus on migration to v3 to shrink the size of v2 and thus de-risk v2 (which may certainly be a practical strategy). There are always revenue/risk considerations, and we hope that the above provides some perspective on the risk side. As always, we would appreciate the community’s feedback here as they consider the tradeoffs.

1 Like