This section describes the risks associated with the Rysk DHV alongside a mitigation for that risk. It is important to note that all mitigations are not complete solutions to the problem as some risks are simply unavoidable, the mitigations are put in place to help reduce risk.
- DHV could sell options and they can expire in-the-money, meaning that the counterparty can exercise and redeem part of collateral generating a loss for the DHV.
- Options are sold at competitive prices to reduce the impact of an in the money expiry. Delta is hedged to reduce the loss caused by an in the money event, by harnessing the deltas of the rest of the portfolio the portfolio can become resistant to market movement by hedging delta.
- DHV targets delta zero to achieve market neutrality but delta can deviate far from 0, meaning that the DHV could have directional exposure.
- To mitigate this case the DHV-USDC could dynamically hedge trading other instruments reducing the directionality
- DHV options collateral positions could be liquidated in adverse scenarios resulting in loss of funds.
- A liquidation buffer is maintained to ensure that collateral positions can be properly backed, bots check the margin of positions every minute to keep them within healthy bounds.
Each option series has its own "collateral vault" this collateral vault represents all collateral used to collateralise a specific option series. By option series, we mean something like all short ETH 14-OCT-22 $1600 CALLs held by the protocol. Collateral vaults do not share collateral with eachother, they are compartmentalised. e.g. collateral vault with vaultId 1 will represent an options series, will have its own amount of collateral inside and will have its own minimum margin requirements. A collateral vault getting liquidated has no effect on the status of other collateral vaults, i.e. if collateral vault 1 gets liquidated collateral vault 2 will be unaffected by this. Each collateral vault/options series will have its own collateral account (the amount of collateral held in a collateral vault) and a minimum margin requirement which is governed by the collateralisation formula described in Collateralisation. The "margin safety factor" is a proxy for how close a vault is to liquidation. The margin ratio is computed as follows:
represents the margin safety factor of collateral vault i,
represents the collateral held in collateral vault i and
represents the minimum margin requirement for the options held in collateral vault i. If
is 1 or lower a collateral vault is considered liquidatable, above 1 the collateral vault is safe.
When an option is written to a collateral vault, the smart contract intentionally over-collateralises each vault. The amount of collateralisation is governed by what are known as "health factors": there are 4 distinct health factors to be aware of:
- callUpperHealthFactor,: when a new call option(s) is written the option(s) will be collateralised withcollateral, whereis the minimum margin requirement for that option.Currently set to: 1.3 (subject to change)
- putUpperHealthFactor,: when a new put option(s) is written the option(s) will be collateralised withcollateral. Currently set to: 1.2 (subject to change)
- callLowerHealthFactor,: currently set to: 1.1 (subject to change)
- putLowerHealthFactor,: currently set to: 1.1 (subject to change)
Every 1 minute a bot (and a redundancy bot) calculates the
for all collateral vaults by retrieving the
of each collateral vault. If the
for the collateral vault
is higher than
for a collateral vault holding a call option series or a collateral vault holding a put option series respectively, then collateral is removed from vault
and returned to cash, returning the margin safety factor back to the callUpperHealthFactor or putUpperHealthFactor. If the
for the collateral vault
is lower than
for a collateral vault holding a call option series or a collateral vault holding a put option respectively then cash is removed from buffer cash or free cash and put into that collateral vault to return the margin safety factor back to the callUpperHealthFactor or putUpperHealthFactor.
- If the liquidity pool has insufficient funds to safely process user's request then withdrawals will not be processed for an epoch and will be processed when there are sufficient funds in the liquidity pool.
- To mitigate this the sale of longer dated options is postponed to reduce collateral lockups. Other measures such as promoting deposit liquidity might be taken.
- The system is complex and inherently experimental and carries risk of a smart contract vulnerability which may result in total loss of funds.
- The protocol has monitoring via Tenderly, if a security alert occurs there are guardians who are able to pause the protocol to prevent any further adverse scenarios.
- The contracts require cash settlement, meaning an expiry price must be set at the time of expiry. This is managed by bots which have redundancies associated with them. However, the bot failing to update at the time could result in a delayed price for settlement.
- A war room protocol has been established for this scenario and it is possible to rescue this scenario if necessary.