[KNC] MIP12c2-SP2 Collateral Onboarding Risk Evaluation

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Summary Proposed Risk Parameters

Risk Premium: 4%
Liquidation Ratio: 175%
Debt Ceiling: 5 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 20 Dai

Outline

  1. Overview
  2. Metrics and Analysis
  3. Risk Parameters

Overview

Protocol Summary

KyberNetwork is an onchain decentralized exchange that aggregates liquidity from a variety of sources. Orders are relayed to the network via integration partners. KyberNetwork has five main stakeholders.

  1. Reserves or market makers. These are market makers who set limit orders in the network via different types of reserves. There are three main types of reserves: Feed Price Reserves (market making strategy based on an oracle price feed); Automated Price Reserves that use an algorithmic smart contract (similar to the Uniswap bonding curve); and lastly Orderbook Reserves (where one can set a limit price).
  2. Integration partners. These are “merchants”, dapps, or services such as payment processors, wallets and other applications, that are integrated into the network and facilitate or bring market orders. The integration partners utilize liquidity from the reserves.
  3. KNC token holders. Currently, tokens accrue value via token burn, which is determined by network utilization. At the end of Q2 2020, KNC is scheduled to upgrade, adding additional governance features such as staking and voting. The protocol will then allocate a portion of network fees to stakers who also actively participate in governance decisions. Users will decide what portion of the cash flow will be used to acquire KNC for the token burn, and what portion will be directly distributed (similar to a dividend yield).
  4. Kyber Company/Team. They currently serve as network maintainers and have all administrative rights to change the system. They grant access to the network by whitelisting new ERC-20 tokens, reserves and integration partners. The Orderbook Reserve is the only reserve type which can be added in a permissionless way. They do not, however, have the ability to confiscate user or reserve funds; they can merely disable an individual or specific reserve from interacting with the network. After the KyberDAO is established, they will still maintain some of these key functions.
  5. Users or market takers. They are market participants which post market orders via different UIs of integration partners.

KNC Token Value Accrual

  • KNC is a currency used to distribute accrued fees between 1) reserve pools, 2) integration partners, and 3) KNC token holders (via token burn). When a ‘reserve’ matches a market order relayed by an integration partner, it pays a 0.25% fee in KNC for the opportunity to have participated in the order flow. In the current fee sharing structure, 30% of the fee paid is allocated to the integration partner and 70% is burned.
  • Token burn: for each trade 0.175% (70% of 0.25%) of the value is burned in KNC token.
  • KyberDAO Staking & Voting: Kyber Protocol will undergo a network upgrade known as Katalyst at the end of Q2 2020. Together with the upgrade, a KyberDAO will be launched which will introduce token staking and voting. Token holders will then be able to vote on a) network fee rate as a percentage of trade volume and b) the distribution of fees between stakers/voters, KNC token burn, and ‘reserve’ incentives. Initially the Kyber team will serve as a maintainer of the KyberDAO and take on certain key roles. After the Katalyst upgrade and establishment of KyberDAO, a formal KIP (Kyber Improvement Proposal) process will be put in place.

Staking, Voting, Delegation and Rewards after Katalyst and KyberDAO

  • Introduction of Epochs. Staking and voting will be done in epochs, a fixed time period expressed in Ethereum blocks which lasts approximately 2 weeks. Rewards will be distributed based on stake amount and voting participation in campaigns which occurred during the epoch.
  • Delegation to Pool Masters. The Kyber team expects the emergence of delegates which will be active participants in governance and charge their own fees from pool contributors. This is similar to (political) delegation on Tezos or Cosmos, where block producers share network fees, but also vote on the behalf of their contributors.

Decentralization & Governance

  • In the current state, the Kyber team is the only network maintainer (although this may change at some point after the KyberDAO is established). As a result, they control admin access to the smart contracts in the form of a multisig wallet. The multisig wallet is only as safe as the security practices behind their key management.

Metrics and Analysis

KNC Token metrics

Daily Active Addresses

The daily active addresses have started to increase lately, due to (perhaps) the Coinbase listing, general crypto adoption, and anticipation for the Katalyst network upgrade and the establishment of KyberDAO.

Source: Santiment

Daily Onchain Transaction Volume (denominated in KNC)

Onchain transaction volume tells a slightly different story than DAA, but in combination the two give us good insight into the nature of token holders who accumulated or held at various points in the token’s history. During the initial days of the token (ICO, initial listings, and frenzy), the DAA was high but transaction volume was relatively small. This indicates that initial holders were more retail-like, dealing with smaller amounts individually. In the middle of the period (2018-2019), we can see an increase in transaction volume despite low DAA, indicating that larger holders were likely accumulating. The most recent period may indicate that traction has been significantly increasing since February and that DAA metric is not being manipulated.

Source: Santiment

Token distribution, return & inflation metrics

token supply 210,728,530.82
circulating supply 179,895,689 85.37%
price $0.68
market cap $122,329,069
implied market cap $143,295,401
returns tokens circulating inflation since
3m 4.94% $0.65 179,239,809 0.37%
6m 262.03% $0.19 168,591,095 6.71%
1y 139.31% $0.28 166,543,752 8.02%
2y -46.03% $1.26 134,461,723 33.79%
since ICO (Sep 2017) 78.95% $0.38 134,132,697 34.12%

Source of data: CryptoCompare, CoinMarketCap, Etherscan

Source of data: CoinMarketCap, Kyber Tracker

Even though KNC has a burning mechanic, the circulating supply is being inflated over time. The protocol burned ~4.9m KNC since launch, but the team and the Kyber company have been steadily releasing vested tokens into the market. Below is the KNC balance over time on the Kyber team multisig address, which holds tokens for the team and company.

Source: Etherscan

Tokens on exchange

Source of data: Nansen-d5

Tokens on Exchange KNC
Binance 33,415,384
Coinbase 31,653,372
Upbit 6,461,968
Huobi 3,968,617
Bithumb 3,865,923
OKEx 2,653,140
Gate.io 1,178,243
KuCoin 1,177,206
Poloniex 607,705
Uniswap 594,162
Kyber 572,229
Coinone 535,182
Gemini 309,251
Other 305,256
Crypto.com 277,819
Bitfinex 208,126
EtherDelta 171,149
IDEX 35,200
HitBTC 22,006
CoinEx 11,361
Bittrex 8,831
Total 88,032,130
out of circulating supply 48.9%
out of total supply 41.8%

Source of data: Nansen-d5

Approximately 41.8% of total token supply is currently in custody of centralized trading venues. The figure is quite high for any asset and presents a certain degree of exposure to exchange hacks and other exchange related issues (such as exchange counterparty risks). With establishment of KNC governance and voting, the custody related risks will be greater as the mechanics offer new vectors to exploit and benefit from large amounts of KNC tokens in the wrong hands.

Source: Nansen-d5

According to the seniority distribution of tokens, approximately one third of the token supply has not moved in the previous two years. This group is likely the first wave of token holders that have either held since the token sale or have acquired the asset shortly after exchange listings. This group is also the most distributed as they represent approximately 60% of addresses. Another interesting observation is the group of holders who have acquired KNC in the preceding year. They hold approximately 60% of the token supply, but represent only 10% of addresses. This may indicate increased institutional interest in KNC.

Trading Data - CEX volume

Aggregated daily trading volume and market share distribution from the largest venues can be seen in the charts below. Total trading volume significantly increased after the Coinbase listing in February 2020. Coinbase also gained a large market share considering how long the token has been listed there. We applied a significant haircut (90%) to trading volume reported by OKEx, as their volume significantly increased simultaneously with Coinbase after their listing, even though OKEx listed the token in 2017 and has relatively much lower token deposits in their custody.

Source of data: CryptoCompare

Source of data: CryptoCompare

Trading Data - DEX volume

DEX KNC Daily Volume 30d Median USD Volume
Uniswap (v1,2) $51,699
0x (v1,2,3) $1,045
KyberNetwork $208,678

Source of data: Uniswap.info, 0x Tracker, Kyber Tracker

Volatility

hourly yearly
90d vol 2.27% 212.76%
1y vol 1.58% 147.55%
2y vol 1.56% 145.67%

Source of data: CryptoCompare

Downside Risk

Source of data: CryptoCompare

Current presence in leverage and lending platforms

The only notable presence for KNC on leverage and lending platforms is Aave, which has approximately $2.12m of total supply, with only about $20k borrowed. We could not find any KNC deposits in centralized lending services such as Celsius, BlockFi, Nexo.

Source of data: Corresponding websites of considered platforms

KyberNetwork Protocol Metrics

Daily trading volume and number of daily trades

Network is showing a healthy trend in trading volume, which is also supported by growth in the number of daily trades.

Source of data: Kyber Tracker

Source of data: Kyber Tracker

Miscellaneous

  • Legal status: Due to lack of relevant expertise, we choose to omit any legal risk analysis surrounding either the protocol or the token. However, we encourage the community to incorporate this risk into the risk management process accordingly.
  • ICO / Funding process
    • Between a public token sale in September 2017 and a private round the team raised ~200k ether or ~$50 million.
    • A whitelisting and registration process required KYC and an Ethereum address. US Citizens and individuals or organizations in the sanction list were prohibited.
    • Token distribution. Initially 226m tokens: 61.06% Public, 19.47% Company, Founders/Advisors ~15% (fully vested in 2 years, with a one year lock-up period), ~4.47% Seed Investors. Unsold tokens were burned - 10,374,651.16, total supply after token sale was 215,625,348.84 and tokens in circulation at Oct 15 were 134,132,696.93 or 62.2%.
    • 50% of the raised funds was intended to be used for establishment of a reserve to facilitate liquidity in the protocol and in addition they planned to tokenize non Ethereum assets on Ethereum.
    • Public sale price was 600KNC = 1 ETH or 0.00166 KNC/ETH.

Summary of Notable Risks

  • Approximately 48% of the circulating supply is currently deposited in centralized trading venues, representing some degree of counterparty risk. Additionally, the project is planning to implement staking and voting, which may increase this exchange exposure.
  • The Coinbase listing significantly expanded token metrics such as price and trading volume. New demand is a positive sign, but we must consider that the token could be subject to unsustainable “Coinbase listing” hype.
  • The Kyber Team will most likely remain the only maintainer of the network in the short to midterm, which means that the central point of failure represents a certain degree of counterparty risk.

Proposed Risk Parameters

Risk Premium: 4%
Liquidation Ratio: 175%
Debt Ceiling: 5 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 20 Dai

We use the model described from the governance call here: a credit risk model that estimates the loss distribution of a portfolio of KNC Vaults. Risk parameters are estimated from this hypothetical loss distribution. Inputs to the model are derived from trading data along with stressed input parameters. A link to our model specification with inputs and outputs can be found here. Auction parameters have been selected to mirror those for ETH, with the exception of the lot size that has been normalized to a ~$20,000 amount

Lead Researcher: Marko Stemberger

Sources
Santiment; https://santiment.net/; May, 2020
CryptoCompare; https://www.cryptocompare.com/; May, 2020
CoinMarketCap; https://coinmarketcap.com/; May, 2020
Etherscan; https://etherscan.io/; May, 2020
Kyber Tracker; https://tracker.kyber.network/#/; May, 2020
Nansen-d5; https://nansen.ai; May, 2020

13 Likes

Great work Cyrus, Marko and company! This is really informative stuff!

1 Like

Chart layout/template with the metrics used in this report:

https://app.santiment.net/studio/knc-network-overview-346

Few more added to give a bit more of a behaviour analyses of the network holders.

1 Like

This is exiting! MCD is really coming into the light now with so many new collateral types on the horizon. KNC looks like a good fit. Thank you providing all of this.

1 Like

Hey @cyrus - thanks for all this - very impressive & informative. Could we talk a little about:

  1. The scheduled upgrade in Q2 2020

Will this materially change the KNC ERC20 token contract and, if so, has the SC domain team been made aware and do they have a plan to handle this? What will happen if the adapter is frozen for some period and there is significant KNC locked in the system?

  1. Smart contract risk:

Is the plan for KyberDAO to replace this kind of admin access? Or is is just about more open voting on fee structure, rates and distribution? That multisig wallet makes me nervous…

I very much agree that 41.8% of total supply on centralized trading venues, with the establishment of of governance and voting, could lead to new vectors for exploit and benefit. This is not necessarily unique to Kyber, but is quite a profound point I think it is worth re-highlighting in any tl;dr.

  1. Legal risk:

I can understand your hesitancy here, but how - practically - is “the community” meant to achieve this? Go troll Stephen Palley and Preston Bryne until they either send herring/marmots to attack us or provide an opinion? :joy:

1 Like
  1. When my team looked into it, we did not see anything in the research materials (blogs, etc), but given the significance of the changes, we should probably assume there is. I’ve already pinged @Mariano_Conti to double check on this and establish a line of communication with them. My team did not speak to the Kyber team directly, though.

  2. Voters will be able to influence fees structure, rates, distribution, etc, but the Kyber Team will maintain control over admin access.

  3. Honestly, I don’t know. It’s one that’s so far out of my domain that I would consider it as foreign to me as the smart contract risk. Having the community reach out to more qualified people though seems like a natural starting point. For example, community members such as Chris Padovano have been great in this area. I think as the DAO matures over time it will become natural to formalize or professionalize some of these working arrangements. I don’t think we can just go out there and ask someone to give us some numbers today, though.

3 Likes

I think this is the key. I’m hoping that we are able to find community members that have legal experience and encourage them to share that experience in whatever manner they are able given the professional restrictions they are under.

Governance Poll is now live.

https://vote.makerdao.com/polling-proposal/qmranqqaxjrhet8xorhkqtgki5mzxa1mizudoylcsrfapt

1 Like