[SLP-SUSHI-ETH] Collateral Onboarding Risk Evaluation

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  1. Summary Proposed Risk Parameters
  2. Overview
  3. Metrics and Analysis
  4. Risk Parameters

Summary Proposed Risk Parameters

Stability Fee: 5%
Liquidation Ratio: 165%
Debt Ceiling: 1 million DAI
Cut: 0.99
Step: 130 seconds
Buf: 1.30
Cusp: 0.4
Tail: 200 minutes
Chip: 0.1%
Tip: 300 DAI
Ilk.chop: 13%
Tolerance: 0.5
Ilk.hole: 1m DAI
Dust: 10,000 DAI

Note that the Dust parameter for most vault types may be updated in a poll this week (per this signal request). If the vote fails, this vault type will be onboarded with 5,000 DAI Dust instead.

Overview

Protocol Summary

Sushiswap is a fork of Uniswap v2 with few slight changes such as introduction of governance token and its tokenomics. At the time - late August 2020, Uniswap did not have a governance token which could be rewarded for “liquidity mining” and incentivisation of protocol usage; this instance enabled opportunity for “vampire mining”, which aimed to shift current asset liquidity used in Uniswap to the Sushiswap - the event was seen as greatly successful.

Initial main developer known as Chef Nomi pulled a “rug pull” on the community where he withdrawn his SUSHI/ETH liquidity and cashing it out for ether; the situation was later resolved with the help of Sam Bankman-Fried who managed to return the protocol to the community, via establishing a multi-sig with well-known crypto community individuals as signers, Chef Nomi also returned the funds to the projects treasury.

Sushiswap as fork of Uniswap is using the same automated market maker (AMM) methodology with the x*y=k formula to quote prices. The model relies on market depth being constructed from the pooled liquidity and market agents making swaps with it, where price slippage is relevant to the swap order size and the size of the pooled liquidity. Liquidity providers known as LPs are earning trading fees and are subject to “liquidity mining” rewards from the protocol, but are exposed to “impermanent loss” which is loss which can occur after the pooled assets fluctuate in price relative to the value of asset if they would not be deployed into the pool at all. In general, the accrued fees in combination with liquidity rewards often completely offset the impermanent loss.

The main difference between the two protocols is that Sushiswap distributed accrued protocol revenue from 0.3% protocol trading fees between LPs (0.25%) and xSUSHI token holders (0.05%). xSUSHI is received after depositing SUSHI into a pool called SushiBar; a way to distribute a portion of accrued revenue to token holders. In addition Sushiswap is continuously rewarding LPs with a liquidity mining program, where in addition to collected trading fees, suppliers are rewarded with the protocol token SUSHI.

Sushiswap governance works via voting, where votes are in the form of SushiPowah, which is a voting metric and works as followed; each SUSHI in the SUSHI-ETH pool is worth 2 SushiPowah and each SUSHI held via xSUSHI is worth 1 SushiPowah. Votes are managed on snapshot.page, quorum of at least 5 million SushiPowah is required and the multisig signers mentioned previously implement the changes into the protocol.

SLP-SUSHI-ETH is the Sushiswap LP (SLP) token consisting of SUSHI and ether; currently it is the second largest pool by liquidity in the protocol, holding over $500M in assets, which means there is approximately $250M worth of each asset deposited.

One important difference between how Sushiswap LPs will be implemented into MCD compared to Uniswap LPs is that prior will be using the CropJoin Adapter (SushiJoin), meaning that SLP collateral will be able to earn liquidity mining rewards; SLP-SUSHI-ETH receives the highest incentivization of any pair on Sushiswap.

Metrics and Analysis

Trading volume on CEX & non-custodial venues

Sushiswap LP tokens (SLP) can be minted and redeemed from the pool contract with the underlying assets. There is essentially no trading of the SLP-SUSHI-ETH tokens themselves, so liquidity of LP tokens is best understood as a function of the liquidity of constituent assets. As an example, keepers can liquidate LP token positions by redeeming the token with the contract and then selling the underlying assets. An important thing to note is that due to the pricing mechanism used by AMM based venues, the real asset weights in the pool do not always reflect the target weight (in this case 50:50), which means that Keepers must take this into account when redeeming the underlying assets.

Token Distribution & Issuance Schedule

SLP-SUSHI-ETH tokens are created and redeemed via the Sushiswap pool contract, so the total supply of LP tokens depends on users’ decisions to enter or exit the liquidity pool. There are no centralized minting functions or other inflationary factors in token supply.

The SUSHI token has a fairly concentrated supply distribution, with over 20% of supply controlled in a 6 of 9 signature gnosis multisig. This has been accumulated from a 10% share of minted SUSHI tokens flowing to the dev fund, as well as tokens held on behalf of past LPs under manual 6 month vesting. Additionally, new tokens will be minted and distributed to liquidity providers gradually until the total SUSHI supply reaches a maximum supply of 250 million tokens.

Token Deposits on Trading Venues and DeFi Exposure

SLP-SUSHI-ETH is not listed for trading on any centralized or decentralized exchange venues, as creation and redemption is available directly through the pool contract with no fees or slippage.

Vast majority of SLP SUSHI-ETH tokens (98%) are deposited into Sushiswap’s incentivized SUSHI farming pool - MasterChef Staking Pool. SUSHI is primarily traded on Sushiswap, but is also integrated with other protocols like Cream Lending.

Downside Risk

Because Sushiswap LP tokens are not traded independently, it’s not possible to check previous trading history to assess downside risks. But, the invariant function (y*x=k) allows for calculating drawdowns deterministically based upon the price performance of constituent assets. Details about LP returns can be found in Uniswap’s blog and this Medium post.

Assuming the price of ETH stays stable, a decline in the price of SUSHI will lead to a corresponding decline in the price of SLP-SUSHI-ETH from two factors: the loss in value of the 50% of the pool already held in SUSHI, and additional losses caused by “impermanent loss”.

SLP-SUSHI-ETH percentage loss = loss from existing holdings + impermanent loss

Loss from existing holdings = SUSHI percentage price change * SUSHI allocation (50%)

Impermanent loss = ((2 * sqrt(1 + SUSHI percentage price change) / (2 + SUSHI percentage price change)) - 1) * (1 + (0.5 * SUSHI percentage price change))

E.g. if SUSHI price suffers 50% percentage drop:

Loss from existing holdings = -0.5 * 0.5 = -0.25

Impermanent loss = ((2 * sqrt(0.5) / 1.5) - 1) * (1 - 0.25) = -0.043

SLP-SUSHI-ETH loss = -0.293

50% drop in SUSHI price leads to 29.3% drop in SLP-SUSHI-ETH value, assuming no change in ETH price and excluding any positive fees earned by LPs. The relationship between SUSHI and SLP-SUSHI-ETH price performance is shown below. Note that this same effect applies to changes in the price of either pool asset, so declines in ETH price will also impact the value of SLP-SUSHI-ETH.

Sushiswap has only been live since late August 2020, but based on the historical ETH and SUSHI prices and Uniswap’s invariant formula, SLP-SUSHI-ETH would have experienced substantially fewer sharp drawdowns in price than SUSHI alone. The largest price drawdown would have been 41%, experienced on 19 May 2021 on the same day when SUSHI price fell 48% (and ETH price fell 31%).

image

Source: Coinmarketcap, June 2021

Historical Fee Returns

Sushiswap liquidity pools earn a 0.25% fee from each trade. Over time, this income accrues to liquidity providers and helps counteract negative effects of impermanent loss. In addition, SLP token can be staked for additional SUSHI rewards, which are not equalized between pools and can also change over time based on what kind of liquidity and users protocol wish to attract more.

Average daily annualized fee earnings for SLPs were 15.81%. In addition, SLP collateral will be earning SUSHI rewards, which substantially increase their expected return. The return of SUSHI rewards is based on several factors, such as liquidity mining reward allocation to the pool, amount of capital in the pool, price of SUSHI and thus fluctuates; at the time of writing, annualized SUSHI reward for SLP-SUSHI-ETH was ~33%.

Source: Sushiswap.vision, June 2021

Summary of Notable Risks

  • SLP-SUSHI-ETH is exposed to Sushiswap governance and custody risk. A large portion of SUSHi tokens are held in a 6 of 9 multisig, and unexpected distribution or hacks could cause the value of the LP to drop significantly. Multisig signers are well known/respected individuals so the risk of intentional malicious actions is considered low.

  • Sushiswap may face significant challenges from Uniswap v3. If it’s unable to maintain market share, this will negatively impact SUSHI token and LP value and reduce the pool of capital able to borrow through this vault type.

  • SLP-SUSHI-ETH will suffer from impermanent loss when SUSHI or ETH experience large moves. LP borrowers may have an incentive to repay their debt and remove liquidity during large relative price moves, which may outpace LP earnings. This could have a negative impact on SUSHI token liquidity which would place other liquidations at higher risk.

  • Sushiswap governance can change SUSHI liquidity mining reward allocation, but this is the primary pair so it is likely to remain favored.

  • The SLP collateral will be farming SUSHI rewards which is a novel type of vault due to additional functionality and present an additional smart contract risk.

Proposed Risk Parameters

Stability Fee: 5%
Liquidation Ratio: 165%
Debt Ceiling: 1 million DAI
Cut: 0.99
Step: 130 seconds
Buf: 1.30
Cusp: 0.4
Tail: 200 minutes
Chip: 0.1%
Tip: 300 DAI
Ilk.chop: 13%
Tolerance: 0.5
Ilk.hole: 1m DAI
Dust: 10,000 DAI

Note that the Dust parameter for most vault types may be updated in a poll this week (per this signal request). If the vote fails, this vault type will be onboarded with 5,000 DAI Dust instead.

We used the model from the Collateral Risk Assessment Guide here. A link to our model specification with inputs and outputs can be found here. Data for graphics included in this report can be found here.

Lead Researcher: @monet-supply

Sources:

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