Compound Finance 3rd Milestone Announcement

This update provides an overview of the recent economic audit conducted by Chainrisk on Compound V3, highlighting efforts to optimize risk management and enhance protocol stability. The audit involved stress testing the protocol under various market conditions on the Arbitrum One Chain, particularly within the USDC market. Through advanced simulations, Chainrisk aimed to identify optimal risk parameters that maintain capital efficiency while ensuring security, demonstrating the effectiveness of their risk management strategies within the decentralized finance (DeFi) ecosystem.

Scope of the Economic Audit

The audit's primary goal was to develop a robust market risk calculation framework for Compound V3. Chainrisk's analysis focused on several key collateral assets:

• Wrapped Ether (WETH)
• Wrapped Bitcoin (WBTC)
• GMX
• Arbitrum (ARB)

These assets are essential in the protocol’s borrowing and lending mechanisms. By analyzing how these assets perform during periods of volatility, Chainrisk aimed to understand their risk exposure and optimize risk parameters accordingly. The audit was particularly relevant because the Arbitrum One Chain has emerged as a vital hub for decentralized finance (DeFi), and ensuring the stability of protocols operating on it is crucial.

The audit highlighted the need to balance capital efficiency with security, ensuring that users can maximize returns while minimizing the risks of over-leveraged positions. Chainrisk achieved this by setting thresholds that ensure the protocol remains resilient even during market crashes or periods of extreme volatility.

Chainrisk Simulation Engine

The highlight of this audit was the Chainrisk Simulation Engine, a modular testing environment capable of conducting high-fidelity simulations. This engine allowed for realistic modeling of various components within the Compound V3 protocol, including:

• RiskEVM (Rust-based Simulation): Responsible for heavy computational tasks, this component handled complex simulations, particularly during stressful market scenarios, to assess the protocol's stability.
• On-Chain Simulation: By replicating real-world scenarios through backtests on forked networks, this component ensured the simulations were grounded in actual on-chain data, providing precise and practical risk insights.

The simulation engine’s ability to mimic real-world conditions allowed Chainrisk to deliver a robust analysis of how Compound V3 would respond under different scenarios. This was essential for making informed recommendations to adjust risk parameters, thus enhancing both capital efficiency and security.

Key Metrics & Results

The audit introduced crucial metrics such as Value at Risk (VaR) and Liquidations at Risk (LaR) to better understand the protocol’s exposure:

1. Value at Risk (VaR): A measure of the maximum potential loss over a specified period, calculated using thousands of simulations to capture a wide range of possible scenarios. This provided a comprehensive view of the risks associated with different collateral assets.
2. Liquidations at Risk (LaR): Similar to VaR, this metric focused on the risk of forced sales (liquidations) within the protocol. It helped in understanding how often and under what conditions collateral might be sold off, which is critical for managing stability during market downturns.

The simulations showed that Compound V3 had similar risk profiles across different asset classes, which is a positive indicator of uniform behavior under stress. Each simulation ran independently, offering unbiased results that helped Chainrisk develop comprehensive strategies to handle various market conditions.

The insights gained from these simulations allowed Chainrisk to provide tailored recommendations on how to adjust risk parameters, including:

• Optimizing collateral requirements to ensure users can safely leverage their assets.
• Adjusting liquidation thresholds to mitigate the risk of forced sales during volatile periods.
• Setting capital efficiency parameters to maximize returns without compromising on security.

Conclusion

In conclusion, the audit conducted by Chainrisk for Compound V3 on the Arbitrum One Chain highlighted the importance of strategic risk management in decentralized finance. By using a detailed and simulation-driven approach, Chainrisk was able to suggest effective ways to enhance the protocol’s stability and efficiency, ensuring it can withstand varying market conditions.