It’s no secret that the recent retrenchment in the crypto market has left many — even industry veterans — in a state of shock. In 2022, the term “DeFi Summer” is earning a connotation that is 180 degrees out-of-phase from the heady days that inspired the term just two years ago.

This means that the entire cryptocurrency sector is undergoing stress testing at levels unseen since the COVID-driven crash in March 2020, a time before most DeFi protocols existed. Cascading liquidations continue to crater major crypto assets, with many overleveraged and underwater.

Underlying Assumptions

Much of DeFi was built out during the DeFi Summer of 2020 and, therefore, the sector was saddled with many inaccurate, underlying assumptions. So what can we learn from the current environment and what does it take to build sustainable DeFi services?

Celsius Continues To Rapidly Repay DeFi Loans

The security principle of “defense in depth” comes to mind: The idea of deploying multiple measures to ensure robustness and availability. Too often, the message in DeFi begins and ends with “We’ve been audited!” But there is so much more:

Extensive Monitoring:

DeFi works when potentially unhealthy activity (debt positions, token peg, yield strategies, etc.) is not passed to the end user. Protocols should actively track, report, and catalog performance and health of assets, pools, strategies, positions, and so on 24/7/365.

In practice, this looks like dashboards with real-time reporting and historical trend documentation, triggering alerts when something of note happens (i.e., when a loan goes underwater). Bonus points for implementing redundancy across this reporting in case certain individual nodes or bots are taken offline.

Automated Rebalances and Servicing:

“Keeper bots” can listen in on these alerts and perform maintenance and upkeep required. In a yield aggregator, this looks like shifting collateral ratios and migrating weight out of unprofitable strategies. In a lending market, this looks like adversarial liquidations that keep debt from going from dangerous to defaulted.

Synergistic Strategies:

Strategy risk can also be mitigated by an intentional approach to which types of assets interact with one another — what types of loans are taken against which types of collaterals. Some assets are highly correlated, while others are not. For example, one can limit loans to stablecoins and “like” assets (such as ETH collateral; LINK loan) to alleviate any multiplied risk where the collateral may dump while the loan simultaneously pumps.

Conservative Collateral Benchmarks:

The name of the game in DeFi is capital efficiency, but not all strategies to increase efficiency are equal. Collateral rates in lending markets and CDPs must be conservative enough to absorb debt and close positions without incurring losses to the protocol. In a yield aggregator, all strategies that take advantage of loans or leverage should follow generously over-collateralized benchmarks. This insulates strategies from erroneous wicks or flash crashes.