[Discussion] Safety Module

Governance
5

Hey @Llamaxyz, thank you for posting this! Very exciting to see the conversation move forward after our initial inquiry on the topic!

Doing some analysis on our end, our primary concern is sustainability of the strategy. So far in 2023, emissions to incentivize staking in the Safety Module are 4.8x revenue earned from the covered instances (not including flash loan revs). SM AAVE incentives are funded by the Ecosystem Reserve. So that gives this strategy roughly a 4.5-year runway.


Notes: run-rate doesn’t account for third-party payments out of the ecosystem reserve.

Regarding design considerations:

  1. Treasury/Currency Alignment
    a. SM incentives come from the treasury, which is recouped with revenues from borrowing, flashloans, and liquidation fees. So in a sense, this insurance cost should take into consideration the DAO revenues that are funding it.
    b. The DAO earns revs in the tokens that are borrowed and then pays for insurance in AAVE. There is an obvious mismatch here between revenues, the asset being used to insure, and the asset used to pay for it. Diversification is a reasonable goal (transition DAO’s treasury from a large AAVE allocation), but this should be explicit rather than simply convenient. Especially since the treasury gets more diverse each day, since aToken revenue is never AAVE.

  2. Risk Budget.
    a. The risk budget can be defined as any spending that goes toward preventing lending losses. This includes paying Gauntlet and Chaos Labs to set params that will protect depositors as well as expenses allocated for an “insurance” or safety module. Importantly, part of the payment for Gauntlet’s services includes deposits into an insolvency fund.

  1. Effectiveness
    a. As we stated in our post a few weeks ago, using AAVE or BPTs as collateral for your insurance pool is heinously ineffective. Only ⅓ of staked assets can be used and likely only ⅔ or less of that can actually be recouped from the market in a firesale. There are alternative ways that achieve the desired outcome, or at least present less risk, which we should (in theory) be optimizing for (have an insurance fund to repay depositors in the case of bad debt).
    b. The name of the game here is liquidity. Stablecoins and ETH are by far the most liquid assets and should be prioritized in any insurance fund research/allocation.

  2. Tokenomics
    a. Currently, the Safety Module functions to serve AAVE tokenomics at the expense of practicality. The tension between AAVE utility and the SM’s purpose as insurance is the main source of the issue, and it’s worth exploring the (at least partial) separation of these two functions).

  3. BizDev and Diversification
    a. The desire to make assets in the SM productive holds weight, if they are not productive then this increases the cost the DAO would need to pay to attract depositors. That is the tradeoff. This also provides an opportunity to diversify risks away from the Aave protocol. This might be heresy, but to put SM assets on Aave to be there in case something goes wrong on Aave sounds ill-advised. Further, it is an opportunity to support partners. Whether that is Lido, Balancer, Curve, Yearn, or others. The risk team will of course be tasked with thorough analysis but there might be an opportunity here.

h/t Kentrell Key on the data/viz

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