Top Risks for DeFi Users and Investors According to Moody's and Gauntlet - Aliens: AI Crypto News & Markets Updates












Top Risks for DeFi Users and Investors According to Moody's and Gauntlet


Wed, Jan 19, 2022


Aliens TLDR

Decentralized finance ( DeFi ) is rapidly evolving, but insufficient transparency, a lack of shared awareness about its risks, and methods to measure and mitigate those risks continue to pose challenges to its users, according to a report by international risk assessment firm Moody’s.

Prepared in cooperation with financial modeling platform Gauntlet, Moody's analysis identifies three risks typical for traditional lending relationships: valuation risk, or changes in the valuation of the loaned funds and the loan amount, including interest; opportunity risk, or the likelihood of a more profitable offer appearing in the future; counterparty risk which results from informational asymmetry between the borrower and lender who each could have better knowledge of their side of the bargain.

On the lending side, due to the current DeFi state, only overcollateralized loans are possible; said the report, adding that: "Adverse selection largely becomes a function of proper collateral valuation, which is less of a concern with sufficiently liquid collateral." The second conflict is principal-agent, and it arises in DeFi through the mismatch in incentives between investors in the platform, such as liquidity providers or lenders, and those who govern it.

MakerDAO, for example, which oversees the stablecoin DAI , uses the competing DAI Savings Rate and platform stability fees as its primary methods to regulate loan supply and demand, explains the report -- creating and destroying their MKR governance token to "satisfy platform treasury discrepancies." This, according to Moody’s and Gauntlet, "directly impacts the price of MKR, often to the detriment of investors." The analysis recognizes that, taking into consideration the rapid evolution and rise in popularity of DeFi, it is difficult to properly quantify risk.

“This leads to the most important factor in understanding platform risk exposure: mitigation techniques,” Moody’s and Gauntlet said, explaining that: “While all DeFi platforms may depend on similar primitives – namely the existence of a smart contract-supporting blockchain and crypto-accessible collateral – the economics coded into the protocol’s design, the quality of the smart contracts and continued maintenance by developers, and the dynamic tweaking of key parameters by governance holders dramatically impact risk quantification.” The analysis concludes that consistent risk modeling for DeFi must consider all of the identified sources of risk for protocols: contract, market/currency stability, oracle/external dependencies, governance, regulatory, as well as cooperation.

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