Summary
Based on recent insights provided by the Convex and Frax teams, the Risk Working Group (RWG) recommends a reduction of CF in the cvxFXS market on FiRM, with the overall goal of gradually bringing this value to 0 and sunsetting the market following multiple on-chain proposals, allowing borrowers time to adjust.
Background
As part of our ongoing efforts to enhance FiRM attractiveness as a lending platform, the RWG periodically advises on proposed adjustments to market parameters. These adjustments, which may include changes to daily borrow limits, liquidation factors, and market supply ceilings, are meticulously evaluated by the RWG. The goal is to strike a balance between attracting new users and maintaining the platform’s stability and security.
The cvxFXS market has emerged as a key focus, warranting a reevaluation of its parameters to align with the latest market conditions and risk profiles. As of May 6th, 2024, the cvxFXS market is FiRM’s 7th most utilized market, with $1.38M in deposits and $635k in borrows, across 4 open positions. cvxFXS FiRM users also have, on average, a borrow limit % of 70.71%, amongst the highest collaterals.
Recent developments in cvxFXS liquidity and peg had led the RWG to call upon its guardian role to pause FiRM’s cvxFXS market. The unexpected breakdown of collateral integrity occurred in early March and materialized in less than a week, leading to the existing market parameters no longer accurately reflecting the risk associated with this collateral type. Since then, cvxFXS liquidity (and consequently peg) has greatly improved, driven by what we believe are permanent bullish catalysts driven by the Frax Singularity Roadmap and the reactivation of the fee switch via snapshot governance. For the first time since 2023, Frax ecosystem revenue will be distributed to $FXS lockers.
The necessary conditions the RWG was seeking to reevaluate the market have been met, as outlined in the risk assessment summarized below. However, recent insights provided by the Convex and Frax teams, mentioned below, have led us to recommend that the DAO push forward a series of proposals to gradually sunset the market.
Risk Assessment
The recent in-depth assessment by the RWG, which can be accessed here, presents an analysis of the market’s current state, the strengths and weaknesses of cvxFXS as a collateral option, risk factors, and proposed parameter adjustments. Key highlights of the assessment include:
Methodologies:
- A comprehensive asset scoring model evaluates the risk of assets using various factors such as market capitalization, trading volume, price volatility, token distribution, project fundamentals, and token utility.
- A comprehensive RWG Risk Assessments which aims to identify, evaluate, and prioritize risks associated with specific entities or protocols to inform risk management strategies.
- An analysis of on-chain liquidity including a breakdown of holders and liquidity pool providers and assessment of stickiness, catalysts, and baseline guarantees.
- Price impact simulations which measure the current state of liquidity and compare it to previous snapshots. The results lead us to determine whether the current parameter settings for the studied market are appropriate in the context of providing liquidators with a profitable liquidation, and in avoiding liquidation cascades for a variety of stress-test scenarios. This is done via our in-house devised frameworks.
Outcome:
- After receiving information from the Convex team regarding future liquidity expectations for cvxFXS and FXS on mainnet, coupled with Frax team’s intent to migrate FXS-related liquidity to Fraxtal, the RWG recommends to gradually reduce the Collateral Factor (CF) for the cvxFXS market to 0. Convex plans to shift incentives slowly to Fraxtal, which will lead to a gradual migration of liquidity. As cvxFXS liquidity on mainnet shrinks, our cvxFXS market will become increasingly unsafe to operate. This, coupled with the uncertainty surrounding Frax’s intentions with FXS liquidity on mainnet, has led us to recommend a course of action that proactively manages risk by acting early, rather than waiting for the above scenario to unfold. adjusting the Collateral Factor accordingly. If approved, the sunsetting of the cvxFXS market will be achieved through gradual reductions in CF across multiple on-chain proposals to allow existing borrowers sufficient time to unwind their positions.
Parameter Recommendations:
- The RWG recommends the cvxFXS market remain paused.
- The RWG recommends a decrease in collateral factor from 65% to 50%. This will be followed by a subsequent proposal recommending a further reduction in CF, the end goal being a final proposal that sets CF to 0 and, in doing so, sunsets the market.
- The RWG recommends raising the liquidation factor from 37.1% to 54%. The rationale for adjusting the liquidation factor for this market was outlined in governance Proposal 176. At the time, the precise revision to Liquidation Factor in the cvxFXS market had been determined but omitted as the market had been recently paused.
- Supply Ceiling, Collateral Factor, liquidation incentive, minimum debt, and daily borrow limit are recommended to remain unchanged due to their effectiveness in managing risks and maintaining market equilibrium.
The recommended changes are designed to have no adverse impact on the protocol’s ability to conduct profitable liquidations or increase the risk of liquidation cascades, as per the findings from the FiRM collateral parameter modeling.
Conclusion
The proposed parameter adjustments for the cvxFXS market are a strategic response to its evolving risk profile and market conditions. The RWG emphasizes continuous monitoring and adaptation to the evolving liquidity picture to ensure effective risk mitigation.
On-Chain Actions
- Decrease cvxFXS market’s Collateral Factor to 50%
- Increase cvxFXS market’s liquidation factor to 54%