[ARFC] - Chaos Labs Risk Parameter Updates - Aave V3 Optimism - 2023.03.22

Simple Summary

A proposal to adjust five (5) total risk parameters, including Loan-to-Value, Liquidation Threshold, and Liquidation Bonus, across two (2) Aave V3 Optimism assets.

Motivation

Chaos Labs’ Parameter Recommendation Platform runs hundreds of thousands of agent-based off-chain and on-chain simulations to examine how different Aave V3 risk parameters configurations would behave under adverse market conditions - and find the optimal values to maximize protocol borrow usage while minimizing losses from liquidations and bad debt.

Note: As a general guideline, we limit the proposed changes by +-3% for all parameters as a high/low bound for a given proposal. This ensures more controlled changes and allows us to analyze their effect on user behavior before recommending further amendments to the parameters if the optimal configuration is outside this range.

Please find more information on the parameter recommendation methodology here.

You can also view the simulation results and breakdown for the different assets by clicking on them on this page.

The output of our simulations reveals an opportunity to increase LTVs and LTs for WBTC and DAI on V3 Optimism, resulting in improved capital efficiency of the system, with no effect on the projected VaR (95th percentile of the protocol losses that will be accrued due to bad debt from under-collateralized accounts over 24 hours) and EVaR (Extreme VaR, the 99th percentile of the protocol losses that will be accrued due to bad debt from under-collateralized accounts over 24 hours)

Simulating all changes jointly yields a projected borrow increase of ~$155,000, with no increase in VaR and Extreme VaR compared to simulations with the current parameters.

Liquidity Analysis:

The TVL in Aave on Optimism (118.71M$) is concentrated primarily on three blue-chip, high-liquidity assets, which together account for ~75% of the supplied assets in $ values: USDC (34%), WETH (28%), and WBTC (14%). Based on our analysis, we recommend increasing the Loan-To-Value (LTV) and Liquidation Threshold (LT) for WBTC and DAI, as we have determined that there is adequate on-chain liquidity to support significant liquidations. Similarly, we recommend reducing the Liquidation Penalty for WBTC, which is set conservatively at 10% to a lower level (8.5%) closer to that of USDC and Ethereum (5%).

Positions Analysis

We have not identified any outsized positions that are actively affecting our recommendations. However, we should call out that ~40% of the on-chain supply of WBTC on Optimism is currently held on Aave, which calls for some caution. We have already proposed and implemented an amendment to the supply cap to limit the concentration of liquidity on Aave.

Given the blue-chip nature of BTC/WBTC, we expect significant arbitrage buying pressure to offset any slippage that may be created by future liquidations of WBTC and, therefore, recommend reducing the Liquidation Penalty even with the current significant liquidity concentration on Aave. We expect a lower LP to drive liquidators to liquidate positions in smaller portions, pacing the process and allowing the market more time to react.

Recommendations

Asset	Parameter	Current	Rec	Change
WBTC	Liquidation Threshold	75%	78%	+3%
WBTC	Loan-to-Value	70%	73%	+3%
WBTC	Liquidation Penalty	10%	8.5%	-1.5%
DAI	Liquidation Threshold	80%	83%	+3%
DAI	Loan-to-Value	75%	78%	+3%