# Risk Analysis

### Collateralized Debt Position Lending

The most popular decentralized lending protocols employ a borrowing design called _Collateralized Debt Positions (CDP)._ This design allows borrowers to deposit cryptocurrencies as collateral to obtain loans, effectively making them liquidity providers for financial actors. Borrowers often earn interest on the collateral they supply, but also pay a variable or fixed interest to the suppliers of the asset that they borrow.

CDPs are perpetually open until the borrower decides to repay or the value of the asset plus outstanding interest passes a set threshold compared to the value of the collateral provided. In this situation, the position is open to be liquidated. By repaying the loan, a liquidator can claim the collateral used by the borrower at a discount rate.

Lenders can deposit their assets to access the yield paid by borrowers. The yield they receive on their lent assets is determined by a formula that increases borrow interest rates based on the current borrow demand for the asset.

## Economic Risks

### Liquidations

Each borrowed position is backed by collateral that is valued higher than the borrowed asset. If the collateral value of a CDP drops to near the value of the borrowed asset it becomes open for liquidation.

To liquidate a position, any user can repay the outstanding borrowed assets and claim the collateral that had backed the position.

To incentivize users to liquidate these positions, they receive the collateral at a discount of its open market value. If a user is liquidated, they are the party who absorbs the loss of the discount paid to the liquidator.

**Liqwid risk mitigation measures:**

* Selected maximum Loan-to-Value threshold depending on the collateral’s quality
* Selected liquidation bonus depending on the collateral's quality
* Selected supply and borrow caps to limit the amount of an asset that can be supplied or borrowed

### Cascading Liquidations

A subset of liquidations, cascading liquidations occur when initial liquidations impact the price of the collateral at the ecosystem level, causing additional positions to become open to being liquidated. This happens, when the liquidator trades the collected collateral to another asset, causing the price of the collateral to drop further and subsequently exposing additional CDPs to be liquidated.

**Liqwid risk mitigation measures:**

* Adapt the thresholds for the maximum supply cap and borrow cap based on the token liquidity (analysis of the on-chain and off-chain liquidity)

### Bad Debt

An economic risk that can have significant impact on the protocol and users is if the protocol accrues bad debt. This occurs when a CDP open for liquidation is not liquidated, resulting in the collateral being worth less than the debt it is backing.

Bad debt can occur when the collateral does not have a large enough supply in the open market to allow a liquidator to convert it into another asset without incurring fees that make the liquidation unprofitable.

Bad debt in a protocol implies that either the protocol will need to cover the losses of the debt to make the suppliers whole or the debt is left in the protocol meaning that some suppliers will not be able to withdraw the entirety of their assets.

#### Liqwid risk mitigation measures:

* Adapt the thresholds for the maximum supply cap and borrow cap based on the token liquidity (analysis of the on-chain and off-chain liquidity)
* Selected Loan-to-Value threshold depending on the collateral’s quality
* Selected liquidation discount depending on the collateral's quality

## Description of the market risks

### Liquidity risk

A surge in withdrawal can increase the interest rates, pushing further liquidation, or preventing a user to withdraw.

**Liqwid risk mitigation measures:**

* Monitoring dashboards to track inflows and outflows in realtime _(coming soon)._
* Update the interest rates in response to current market conditions
* Update the thresholds for the maximum supply cap and borrow cap in response to current market conditions

### Market Volatility

Unpredictable swings in the crypto market present a considerable hazard. Significant drops in the value of collateral can make health factor inferior to 1 and can prompt liquidation cascades.

**Liqwid risk mitigation measures:**

* Adapt the cap and floor levels for the maximum and minimum price with Liqwid app.
* Use of Liqwid internal price aggregator as benchmark _(NEW to be implemented)._
* Use of risk alerts for users to manage their loan’s collateral _(NEW to be implemented)._

### Oracle Manipulation

Attackers might target the oracles by manipulating the price of some tokens. A classic scenario entails attackers leveraging “low liquidity” tokens, inflating their prices artificially, and then maximizing borrowings against this distorted value, burdening the protocol with unpalatable debt.

**Liqwid risk mitigation measures:**

* Adapt the cap and floor levels for the maximum and minimum price with Liqwid app.
* Use of Liqwid internal price aggregator as benchmark _(NEW to be implemented)._

### Concentration Risks

High asset concentration leads to centralization and potential manipulation risks. By examining the whale concentration, one can gauge asset distribution. A high concentration can imply centralization threats.

**Liqwid risk mitigation measures:**

* Onboard only tokens as collateral which have a critical mass of holders and mindshare
* Onboard tokens with larger market caps, liquidity and CEX listings

### Token implosion Risks

Some tokens can have their price going to zero, when they are subject to hack, fraud or during a depeg events for stablecoins.

In such cases, the Core Team can react given its power granted through the governance to:

* Update the cap and floor levels for the maximum and minimum price with Liqwid app
* Activate the pause guardian which temporarily halts ability to complete actions in an affected market
