A proposal to renew Gauntlet’s 12-month engagement with Compound on continuous market risk management to maximize capital efficiency while minimizing the risk of insolvency and liquidations to create long-term sustainable growth. Gauntlet’s current engagement with Compound runs through September 27, 2022.
For the past three years, Gauntlet has worked with Compound to maximize the protocol’s capital efficiency given an acceptable level of market risk.
Over the past year, Gauntlet has delivered the following:
- Recommendations: Provided 16 sets of parameter recommendations, including 45 total parameter changes to 13 total assets. Gauntlet also provided initial risk parameter recommendations to support the launch of Compound III.
- Community Updates: Built Risk Dashboard to provide insight on risk and capital efficiency for the community. Updated the community on risk developments during Compound Developer Calls. Published educational resources including VaR/LaR Deepdive, Model Methodology, Parameter Recommendation Methodology, and CMA/ES.
- Analysis: Continuously monitored market risk including publishing 2 Market Downturn Reports (May 2022 and January 2022). Provided analysis and recommendations on critical initiatives including ETH Merge, Reserve Factors, Asset Listing Framework, and MKR Borrow Cap. Provided analysis for Compound’s S&P rating, the first credit rating in DeFi history.
In the two years prior to this past year, Gauntlet worked formally and informally for Compound to perform market risk assessments, contribute to treasury management, optimize incentives, calibrate risk parameters, and upgrade the protocol.
Over the past year’s engagement, Gauntlet increased collateral factors for the majority of assets while incurring no major insolvencies despite large market crashes. As a result, borrowers increased their utilization, which generated an additional $5.15m of borrow interest income and an additional $96m+ in total borrow. For more details and further reading, click here.
Gauntlet’s Risk Management platform quantifies risk, optimizes risk parameters, runs economic stress tests, and calibrates parameters dynamically. We use agent-based simulation models tuned to actual market data to model tail market events and interactions between different users within DeFi protocols. Our agent-based simulations are constructed analogously to how transaction-level backtesting is done in high-frequency and algorithmic trading. Gauntlet’s platform provides similar statistical power in these actuarial analyses by modifying these techniques to handle the idiosyncrasies of cryptocurrencies.
Continued support for Compound II
- Coverage of all markets except Legacy (e.g., WBTC) and Deprecated (e.g., SAI, REP)
- Supported risk parameters: Collateral Factor, Close Factor, Borrow Cap, Reserve Factor, and Liquidation Incentive
- Market conditions will determine the frequency of updates. For that reason, no SLA will be preset
[New] Gauntlet will support Compound III, integration is in progress
- Compound III introduces new mechanisms that pose opportunities and challenges as they relate to managing market risk and optimizing capital efficiency, such as a different composition of user positions and risk profiles, updates to reserve size due to the new liquidation mechanism, and new parameters to manage risk with greater granularity.
- Coverage of base asset (USDC) and all collateral assets (WBTC, WETH, LINK, UNI, COMP)
- Supported risk parameters: Borrow Collateral Factor, Liquidation Collateral Factor, Liquidation Factor, Borrow Cap, Collateral Safety Grade, [New] Supply Cap, [New] Target Reserves, [New] Store Front Price Factor, [New] Liquidator Points
Out of scope
- Protocol development work (e.g., Solidity changes that improve risk/reward)
- Formalized mechanism design outside of the supported parameters
- Gauntlet will not look to manage the following at the outset: enabling or disabling a currency for borrowing, optimizing COMP emissions
1-year engagement (Sept 28, 2022 to Sept 28, 2023)
Gauntlet aims to improve the following target metrics without increasing the protocol’s net insolvent value percentage:
- Value at Risk: conveys capital at risk due to insolvencies when markets are under duress (i.e., Black Thursday). The current VaR in the system is broken down by collateral type. Gauntlet computes VaR (based on a measure of protocol insolvency) at the 95th percentile of our simulation runs.
- Liquidations at Risk: conveys capital at risk due to liquidations when markets are under duress (i.e., Black Thursday). The current LaR in the system is broken down by collateral type. Gauntlet computes LaR (based on a measure of protocol liquidations) at the 95th percentile of our simulation runs.
Borrow Usage: provides information about how aggressively depositors of collateral borrow against their supply. Defined on a per asset level as:
where U is the utilization ratio of each user:
Gauntlet aggregates this to a system level by taking a weighted sum of all the assets used as collateral.
- Risk parameter change steps: forum post, community discussion, on-chain vote
- Participation in community calls with explanations of risk parameter changes and any anomalies observed, including but not limited to Discord Developer & Twitter Spaces community calls
- Risk Dashboard (refer to the next section)
- Market Downturn Risk Reviews to provide a detailed retrospective on market risk
As part of this engagement, Gauntlet will update the Risk Dashboard for Compound III to provide key insights into risk and capital efficiency for the community. The dashboard focuses on both the system-level risk in Compound and the market risk on an individual collateral level. Our goal is to help convey our methodology to the community and provide visibility into why Gauntlet is making specific parameter recommendations. Updates to the current dashboard include an updated UI and historical views of protocol statistics, including (but not limited to) total supplies and borrows, collateral usage, and customer acquisition and retention metrics.
Gauntlet charges a service fee that seeks to be commensurate with the value we add to protocols and provides a strong signal of our alignment with the protocol.
The service fee structure will be the same as the previous year’s engagement. The quarterly performance fee is calculated per the following formula: log(Number of Assets, 10) * Total Borrow * Marginal Base Fee tier bps / 4
- Total Borrow is calculated as the 30-day average and rounded down to the nearest $1B. Given that Total Borrow adjusts based on market volatility (e.g., Compound’s total borrow is down ~88% YoY), this metric provides strong alignment with our clients as we are both incentivized to grow this metric, and it allows our service fee to adjust with our clients’ growth.
- When Total Borrow < $2B, there is no basis point fee. In this case, the formula is log(Number of Assets,10) * $1,200,000 / 4 ) — this is effectively the “minimum fee.” As of this posting on August 30th, there are currently 16 assets and ~$1B in Total Borrow. To provide an example - if the quarterly fee were calculated today, it would be $361k (~$1.45m annually).
[New] Insolvency refund: In order to increase our alignment with Compound and put actual “skin in the game,” we will refund a portion of our payment should our risk parameter optimizations incur losses for the protocol during the engagement. Our ultimate goal is to protect the protocol - we stand behind our work and want the community to have confidence in our recommendations.
How this works:
- A portion of our payment (30% of the minimum fee) will be transferred from Compound in a lump sum COMP transfer to an on-chain Polygon vault. Funds will be converted and actively managed by Gauntlet to manage the potential backstop.
- Losses are defined as any new insolvencies related to market risk or oracle failure.
- Exclusions: Issues related to smart contract bugs or related to an underlying asset that is smart contract related and dust accounts (defined as accounts with borrow less than $1,000). Refund does not apply if any Gauntlet risk parameter (excluding Reserve Factor) proposal fails during the engagement.
- Should losses occur, Gauntlet will share an update with the community, and send funds back to the DAO in a timely manner.
- At the end of the engagement, any remaining funds in the vault will be removed, realized by Gauntlet’s Finance team, and no longer eligible for a refund.
- Payment currency will be the same as our prior engagement - denominated in COMP at 30d VWAP. Gauntlet has yet to sell any COMP, but note that we may do so in the future for tax, operational, or other company requirements.
- For the insolvency refund, 30% of the minimum fee will be paid in lump sum fund transfer, at the start of the engagement and deposited in a vault.
- The remainder of the minimum fee will be paid via a year-long Sablier stream.
- Any additional fees beyond the minimum fee will be calculated at the start of each quarter and will be paid via lump sum fund transfer, at the start of the quarter, following a governance vote.
Please share any comments or feedback below. We are targeting to submit a governance proposal by Sunday, Sept 18.
Gauntlet is a simulation platform for market risk management and protocol optimization. Our prior and current optimization work includes engagements with Aave, MakerDAO, Sushi, Synthetix, BENQI, and many others.