Date: 20 January 2023
Status: Request for discussion
Authors: Chutoro & Tenzent
This is a proposal that aims to outline the risk methodology that will underpin the extension of XAI credit lines to silos. It provides a rough guide that will output conservative figures for maximum credit lines extendable. Note that actual credit lines to be extended should be considered on a case-by-case basis and the value that said credit line aligns with Silo’s growth strategy.
The risk framework is composed of 3 main sections:
- Absolute Parameters: minimum requirements for a silo to receive consideration for a XAI credit line extension.
- Protocol-Wide Parameters: maximum $XAI that can be deployed in total throughout all silos or any individual silo based on $XAI on-chain liquidity.
- Silo-Specific Parameters: maximum $XAI that can be deployed to a given silo based on individual factors such as liquidation thresholds, on-chain liquidity, and historical volatility.
Note: The SiloDAO has already extended credits lines to two silos:
- USDC silo: With a maximum of 5M mintable XAI, 2,898,640 XAI is currently minted, that is 58% credit line utilization. Borrowers have collateralized 3,600,939 USDC.
- XAI-ETH silo: With a maximum of 10M mintable XAI, only 303,103 XAI is currently minted, that is 3% credit line utilization. Borrowers have collateralized 462 ETH ( roughly $690,000).
With a total of 3.2M circulating supply, XAI is effectively backed by 89.45% USDC and 10.55% ETH.
This proposal aims to outline a risk framework for $XAI credit line extensions. We have defined the maximum credit line per silo to be 2,348,150 $XAI which will cause $XAI to de-peg upward to 1.1 FRAXBP (USDC+FRAX) via the XAI-FRAXBP pool. We have defined a minimum credit line extension of 100k $XAI for qualified silos.
Firstly, Absolute Parameters will be used to determine whether or not a token’s on-chain liquidity is looked at in more detail.
If this is passed, we will look at the token’s on-chain liquidity via DEX aggregators to determine if a credit line of 100k $XAI can be extended. If so, the asset is deemed suitable for the minimum credit line extension that is set at 100k $XAI.
From here, we will also look at the maximum $XAI swap that can be conducted until slippage approaches liquidation fee; the point at which liquidations are no longer profitable. This amount is defined as the maximum credit line for $ABC.
We will then take the lesser of maximum credit line per silo and maximum credit line for $ABC and multiply it by 70% as a liquidity buffer. Applied to maximum credit line per silo, the maximum depeg (assuming the entire credit line is owned by a single wallet that gets liquidated) will be to 1.02 FRAXBP. This figure is the maximum credit line extendable to that silo.
Note that whilst we will start with the minimum credit line for silos that meet the criteria, the process of extending credit lines to maximum credit line extendable will require additional governance proposals. Secondary characteristics that should be considered are covered in additional commentary.
Absolute parameters are considerations that must be verified before continuing the remainder of the framework. Failure to satisfy any of these criteria would deem the asset unsuitable for credit lines.
As a lending market, Silo is reliant on oracles to source price feeds for token assets. High quality oracles are required to minimize the chance of an oracle exploit.
Chainlink is the most suitable oracle of choice and is mandatory for credit line consideration. Uniswap v3 oracles will also be considered on a case-by-case basis.
An asset must be liquidatable by Silo’s liquidation engine to be considered for a credit line. While many liquidators plug into our markets today, we always assume a scenario where liquidators will not be able to liquidate, and as such the protocol’s liquidation engine kicks in and liquidates the position. Generally speaking, the protocol’s liquidation engine can liquidate all assets listed in the protocol, including XAI. However, there are fringe scenarios where our liquidator might not take the most profitable liquidation path, rendering the liquidation unprofitable to carry out. Those scenarios are limited to a few highly-illiquid token assets.
The core team has done extensive research on all tokens assets that are currently listed on the protocol’s UI (app.silo.finance). The research included many aspects such as:
- Token standard;
- Token smart contract vulnerabilities;
- Whether the token can be liquidated from a technical standpoint;
- If a token rebases or not;
However, the research didn’t include whether a token’s supply can be increased (i.e. minted) nor whether a centralized entity controls token issuance or protocols issuing those tokens.
The core team will run a sanity check on every token asset that the SiloDAO approves for a credit line extension and veto the decision if needed.
Liquidation of collateral deposited to mint $XAI (like in the case of our credit lines) will require liquidators to swap $USDC in exchange for $XAI. $XAI on-chain liquidity is concentrated in the XAI-FRAXBP Curve pool which uses stableswap AMM mechanics. Whilst this does provide a high degree of protection from de-pegs, in the event of a sizeable swap that sufficiently imbalances the pool (such as the liquidation of a large $XAI borrow position), this may cause $XAI to shift off-peg in an upward direction.
Where $XAI costs more than a dollar, liquidators will incur additional slippage that cuts into their Liquidation Fees. If the additional slippage makes liquidations unprofitable, liquidators are not incentivized to liquidate positions, resulting in bad debt to the protocol. With current XAI-FRAXBP reserve balances, we have modeled that the pool can absorb $XAI purchases of up to 2,348,150 $XAI before $XAI will de-peg to 1.10 FRAXBP (Price Manipulation).
As such, the maximum credit line per silo is 2,348,150 $XAI although we do not expect that any silo should receive a credit line of this extent without deeper on-chain liquidity. However, this figure shall be used for the basis of calculating our Silo-Specific Parameters.
Silo-Specific Parameters look at on-chain data of a silo’s base asset to determine:
- Can it safely absorb a $100k credit line
- What is the maximum credit line it can absorb before compromising liquidation fees
If a token can absorb a $100k liquidation, we deem it suitable for the minimum credit line of 100k $XAI. For the purpose of expanding credit lines in the future, we will look at the maximum swap amount it can absorb before total slippage (slippage when selling the collateral asset for $$USDC and the slippage incurred when selling $USDC for $XAI) is equal to liquidation fees, the point where liquidations are no longer profitable.
This process will involve simulating sale of the collateral asset for $USDC via an on-chain aggregator such as Matchaswap and comparing slippage incurred against liquidations fees set for that asset on silo. This amount will be referred to as the maximum credit line for Token $ABC.
The lesser of maximum credit line per silo and maximum credit line for Token $ABC will be multiplied by 70% to provide a liquidity buffer. Where maximum credit line per silo is used, the highest $XAI upward depeg possible in a liquidation will be to 1.02 FRAXBP (refer to Price Manipulation) assuming the maximum credit line has been borrowed by a single wallet which is liquidated in a single transaction.
It should also be noted that the above parameters should be reassessed on a regular basis since variables such as depth of liquidity and our own lending market parameters may change that will affect the efficacy of Silo’s liquidation engine. The core team is currently building a dedicated dashboard to track important metrics related to XAI.
Other parameters that will be noted on a per-asset basis includes characteristics such as:
- Concentration of liquidity providers
- Historical volatility of asset
- Historical liquidity depth of the asset
- Level of decentralization of issuing protocols
- Smart contract risk
Note that while credit lines may be ‘possible’ to a silo, the DAO should remain judicious in which assets receive additional credit lines. Where credit lines are unutilized, it may be prudent to burn these credit lines so they can be extended to other assets with greater utilization. This will require a joint approach with the business development team to properly cross-market credit line opportunities to external protocols to further the growth strategy of Silo.