How to Remove the Human Factor From DeFi Risk Management: The Key Concepts to Know

In the presentation below, Yaron Velner, founder of B Protocol, presented the challenges of mitigating the human factor in DeFi risk management and how to leverage on-chain risk feeds to build trust in DeFi platforms.

Below is a glossary of key concepts mentioned during Yaron’s talk, intended as a supplement to his video presentation.

About B Protocol

B Protocol has been building open-source protocols and infrastructure for risk mitigation and assessment for the DeFi ecosystem since 2020. Through our research arm, RiskDAO, and its novel risk framework, we have supported over a dozen DeFi protocols with risk analysis, research, audits, and monitoring.

Our Risk Oracle and SmartLTV formula automate the process of setting risk parameters for lending platforms in a transparent way, building the next generation of DeFi risk management infrastructure.

Risk Oracle

B. Protocol’s risk oracle is an on-chain decentralized system that provides objective risk-related information about different assets, protocols, or platforms within the DeFi ecosystem. The oracle assesses objective risk-related parameters, such as liquidity and volatility of assets, borrowing and lending caps, liquidations at risk, existing bad debt, smart contract audits, and updates, etc.

Platforms and users can utilize the data provided to make informed decisions regarding listing and managing their lending markets, setting risk parameters that are aligned with the platform’s subjective risk appetite. More information about the risk oracle can be found in B. Protocol’s documentation.

LTV Ratio

LTV is an acronym for Loan-To-Value ratio. It is a measure of the ratio of a user’s loan to the value of their collateral, and it is the DeFi equivalent of a credit score in traditional finance. LTV is a vital metric for gauging the risk and security of loans in the DeFi ecosystem, and loans are often overcollateralized to reduce the likelihood of losses due to defaults, market volatility, or sudden declines in collateral value.

LTV ratio is typically expressed as a percentage and calculated using:

When a user’s LTV rises above a predefined threshold, forced liquidations occur.

Risk Appetite

Risk Appetite is commonly defined as the amount and type of risk that an organization is willing to accept or assume. This appetite can vary from platform to platform and from DAO to DAO as they each have their perspective on what is to be considered as risky. Currently, most risk assessment frameworks in DeFi combine and mash this subjective, qualitative risk appetite with objective and measurable risk-related data feeds.

B.Protocol separates the two through its SmartLTV formula that calculates the LTV based on objective data together with a risk level factor that represents the subjective risk appetite. The risk level factor is a single numerical value that aims to represent a desirable safety margin by accounting for potential deviations from previously observed stats to anticipated values in black swan events. For instance, it considers scenarios where volatility could be three times higher than what was previously recorded.

Ultimately, this factor enables lending protocols to tailor their risk management strategies to their specific goals and tolerances while empowering users with the transparency necessary to make informed decisions.

Circuit Breakers

Circuit breakers are mechanisms that temporarily halt or limit specific activities or trading within a protocol or platform to manage extreme market volatility or prevent sudden crashes. The mechanism is triggered by predefined conditions, such as rapid price declines, high volatility, or abnormal trading volumes. Once activated,  circuit breakers halt activities like trading, lending, borrowing, or other relevant operations to prevent insolvency, protect users from losses, and offer time for the market to stabilize.

B.Protocol’s risk oracle and its first implementation – the SmartLTV formula which is already live on mainnet – can be used as an automated circuit breaker on lending platforms, triggered by rapid market movements or malicious setup of risk parameters.

Learn more about B Protocol here:

B Protocol Website
B Protocol Documentation
B Protocol Twitter
Yaron Velner Twitter

The Blockchain Oracle Summit is the world’s only technical summit that dives deep into the use cases, limitations, and impacts of oracles on the wider blockchain ecosystem. Leading speakers worldwide gathered in Paris to share their work and experience building and using Oracle solutions. Article by Michael Abiodun.