Gauntlet supports many of the points made in the initial post, specifically the need for an explicit Bad Debt budget, and the point that the SM is overexposed to AAVE which could cause structural problems when actually using the SM to cover insolvencies.
This post is timely as we have seen multiple shortfall events over the past year, and any lending protocol should not only be prepared for such shortfall events but should be comfortable with them as the reason that a lending protocol can generate revenue is due to taking on risk.
A Bad Debt budget (we have in the past called this a Security Budget), is an important concept for risk providers in order to better calibrate models and ensure Risk Managers are matching the preferred risk level of community.
We are strongly in favor of establishing this budget and making it explicit for the community. Some additional thoughts on the budget:
- Ideally, this could be defined in terms of a % of the safety module or whatever source of funds is being used rather than an absolute number. This will give flexibility for more dynamic risk management and will scale better with the protocol as funds in the safety module/reserves change over time. This will be easier than needing to decide a budget on a cadence (yearly), and also ensures that risk managers are always calibrating risk parameters for the currently available budget.
- In terms of the actual amount, we believe defining it as X% of the slashable value of the safety module would be an easy starting point for the community to align on and makes it easy to calculate/monitor
- We should clarify the time horizon on which the budget can be used. We think it would make sense for the bad debt budget to represent the single event coverage the protocol has i.e. the USDC decorrelation, or CRV insolvency, rather than a yearly budget. This further makes it easier for risk managers to look holistically at all the risk vectors in the protocol
Excited to see this conversation progress further!