Asset Risks

Risk Methodology and Token Evaluation

Overview

The interconnected nature of the DeFi ecosystem means that risks associated with one component can propagate throughout the entire system. In Rhombus Protocol, liquidity is a fundamental aspect, supporting both the protocol's operations and overall user experience. This documentation outlines a comprehensive framework for assessing token risk within Rhombus Protocol, considering market, counterparty, and smart contract risks. This methodology aims to establish higher risk standards across DeFi and ensure the long-term stability of the protocol.

Participation in Rhombus Protocol

Rhombus Protocol allows users to supply and borrow digital assets through liquidity pools. Suppliers receive protocol-issued rTokens that represent their supplied assets and accrued yield. Each borrowing activity is secured by collateral, serving as a safeguard against defaults and contributing to the protocol’s risk management.

Gas Costs and Complexity

Adding a new token to Rhombus Protocol introduces additional complexity and permanently increases the gas cost of transactions. This is because each token must be integrated into the smart contract infrastructure, raising the overall operational costs.

Financial Implications

From a financial perspective, tokens enabled as collateral are considered assets of Rhombus Protocol, while the borrowed tokens are considered liabilities. Often, the underlying assets and liabilities are distinct, with most borrows denominated in stablecoins and collateral provided in more volatile tokens. This divergence highlights the need for careful consideration before adding new tokens as collateral.

Risk Considerations for New Tokens

Before adding a new token to Rhombus Protocol, thorough analysis is required to ensure that the asset introduces more value than risk. The following guidelines should be observed:

• Only support assets with strong risk profiles as collateral.

• Riskier assets should only be enabled as collateral with Supply/Borrow Cap or under Isolation mode.

• New assets with higher risk and lower liquidity should only be considered for listing in Isolation mode (both for borrowing and collateral purposes).

Isolation Mode

Isolation Mode in Rhombus Protocol allows to list riskier tokens without compromising the protocol's solvency.

Centralization Risk

Accepting centralized assets as collateral exposes the protocol to centralization risks, including the single point of failure associated with the underlying tokens. These risks must be considered carefully when assessing new tokens.

Single Borrow Assets

Tokens with manipulable oracles are listed as single borrow assets. Users who borrow these assets cannot borrow additional assets simultaneously. This approach, known as "Siloed Assets," minimizes the risk of oracle manipulation.

Risk Methodology Framework

The composability of DeFi protocols, including Rhombus Protocol, connects them to a wider ecosystem, introducing various risks. The addition of any new token must be evaluated based on three critical risk categories:

1. Smart Contract Risk

This assesses the technical security of the asset's underlying code. Only tokens with rigorously audited smart contracts should be integrated into the protocol. Even with audits, smart contract risk cannot be fully eliminated, necessitating continuous vigilance. Assets with high smart contract risk should only be onboarded with strict risk mitigations, such as supply caps or Isolation Mode.

2. Counterparty Risk

Counterparty risk measures how the asset is governed and the level of decentralization in its protocol governance. This risk is evaluated based on the number of parties controlling the token’s protocol, the number of holders, and the trust level in the governing entity or community. High counterparty risk assets should be carefully scrutinized before integration.

3. Market Risk

Market risk relates to the size and stability of the asset pool within the protocol, as well as fluctuations in supply and demand. Liquidity must be sufficient to handle potential liquidations without excessive price slippage. Market risk is quantified by factors such as market cap, average daily volume, and normalized volatility.

Risk Scale and Quantification

Rhombus Protocol uses a risk scale to evaluate and classify assets, ranging from the lowest risk to the highest risk. Assets classified as high risk may still be integrated into the protocol, but with significant limitations, such as being restricted to Isolation Mode or being designated as borrow-only assets.

Risk Factors

• Smart Contract Risk: Measured by the age of the contract, number of transactions, and history of security audits.

• Counterparty Risk: Assessed based on governance structure, number of active holders, and overall trustworthiness of the protocol's managing entities.

• Market Risk: Evaluated using market cap, average daily trading volume, and historical volatility over multiple time frames.

Tokens with high risks in any category should only be onboarded with strict risk mitigations, such as being available for borrowing only or with specific limitations in Isolation Mode.

Risk Management and Calibration

To ensure the protocol’s solvency, risk parameters must be carefully calibrated. This includes setting appropriate Loan-to-Value (LTV) ratios, liquidation thresholds, and bonuses to incentivize timely liquidations. Ongoing risk assessments are critical to maintaining the stability and security of Rhombus Protocol.