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Aave V3
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Aave V3
Asset Risk
Introduction
Adding an Asset
Methodology
Risks per Asset
Risk Parameters
Price Discovery
Arbitrum
Avalanche
Fantom
Harmony
Optimism
Polygon
LIQUIDITY RISK
Introduction
Borrow Interest Rate
aToken Liquidity
External Audits & Analysis
Introduction
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RISK PARAMETERS



Each asset within the Aave Protocol has specific values related to their risk,
which influences how they are supplied and borrowed within the protocol. V3 has
better risk mitigations tools with additional risk parameters relating to
security, governance, and the markets.
It is crucial for Aave community understand the underlying risk of each asset:
assess the smart contracts security, understand the risks of centralisation and
market risks. Onboarded assets, onboard their risks to the Aave Protocol. Aave
V3 offers new risk mitigation parameters that allow the onboarding of assets
highly exposed to these risk factors with limits and isolation mode.
All the assets supported by the Aave protocol are added via the Aave Governance
proposal or via the Asset listing admins selected by the Aave Governance.
You can find the risk parameters per markets in:
Polygon
Avalanche

To retrieve the relevant values directly from the smart contracts, see this
section of the developer docs.
RISK PARAMETERS ANALYSIS

The risk parameters mitigate the market risks of the assets supported by the
Aave protocol. Each borrow is based on an over-collateralization with a
different asset that may, be subject to volatility. Sufficient margin and
incentives are needed for the position to remain collateralised in the event of
adverse market conditions. If the value of the collateral falls bellow a
predetermined threshold, a portion of it will be auctioned as a
LIQUIDATION_BONUS to repay a portion of the debt position and keep the ongoing
borrow collateralised.
Market risks can be mitigated through Aave’s risk parameters, which define
collateralisation and liquidation rules.
These parameters are calibrated on a per asset basis to account for the specific
risks identified.
The Aave Protocol V3 introduces 👇🏻 new (additional) risk parameters to provide
a higher level of protection against insolvency.
SUPPLY CAPS

Supply caps define the maximum amount of an asset which can be supplied to the
protocol. Supply caps can be used to limit the protocol’s exposure to riskier
assets and protect against infinite minting exploits. A supply cap is an
optional parameter, and the value will depend on on-chain liquidity of the asset
and total volume of collateral assets in the pool.
BORROW CAPS

Borrow caps define the maximum amount of an asset which can be borrowed. Borrow
caps can be used to prevent traditional and flash borrowing of an asset which
may experience a price exploit and lead to protocol insolvency. A borrow cap is
an optional parameter, and the value will depend on-chain liquidity of the asset
and total volume of borrowed assets in the pool.
ISOLATION MODE

Isolation mode can be used to limit the systemic risk of listing riskier assets.
Isolation mode limits an asset to only borrow isolated stablecoins and only use
a single isolated asset as collateral at a time. More info on isolation mode can
be found here.
SILOED MODE

In V3, new assets with potentially manipulatable oracles (e.g., illiquid Uni V3
pairs where the price can be affected drastically by a single trade) can be
listed in Siloed Mode to limit the overall risk of insolvency of the protocol. A
siloed asset on the Aave Protocol restricts the borrower to single borrows only
(i.e., a user borrowing a siloed asset cannot borrow any other asset).
EMODE

Efficient Mode (”eMode”) allows assets which are correlated in price (e.g., DAI,
USDC, and USDT) to be listed in the same eMode category which maximises capital
efficiency by allowing higher LTVs when both the borrowed and collateral asset
belong to the same eMode category. Currently, only a single eMode category is
defined in the Aave Protocol V3 markets - Stablecoins, category 1.
V3 allows RISK_ADMINS and POOL_ADMIN, selected by Aave Governance, to configure
up to 255 eMode categories, with each EModeCategory having the following risk
management parameters:
LTV (loan to value)
Liquidation Threshold
Liquidation Bonus
Custom price oracle (optional)

Other risk parameters from V2
LOAN TO VALUE

The Loan to Value (”LTV”) ratio defines the maximum amount of assets that can be
borrowed with a specific collateral. It is expressed as a percentage (e.g., at
LTV=75%, for every 1 ETH worth of collateral, borrowers will be able to borrow
0.75 ETH worth of the corresponding currency). Once a borrow occurs, the LTV
evolves with market conditions.
For each wallet, the Liquidation Threshold is calculate as the weighted average
of the Liquidation Thresholds of the collateral assets and their value:
Liquidation Threshold=∑Collaterali in ETH × Liquidation ThresholdiTotal Collateral in ETH Liquidation
\: Threshold= \frac{ \sum{Collateral_i \: in \: ETH \: \times \: Liquidation \:
Threshold_i}}{Total \: Collateral \: in \: ETH
\:}LiquidationThreshold=TotalCollateralinETH∑Collaterali
inETH×LiquidationThresholdi
LIQUIDATION THRESHOLD

The liquidation threshold is the percentage at which a position is defined as
undercollateralised. For example, a Liquidation threshold of 80% means that if
the value rises above 80% of the collateral, the position is undercollateralised
and could be liquidated.
The delta between the LTV and the Liquidation Threshold is a safety mechanism in
place for borrowers.
For each wallet, the Liquidation Threshold is calculate as the weighted average
of the Liquidation Thresholds of the collateral assets and their value:
Liquidation Threshold=∑Collaterali in ETH × Liquidation ThresholdiTotal Collateral in ETH Liquidation
\: Threshold= \frac{ \sum{Collateral_i \: in \: ETH \: \times \: Liquidation \:
Threshold_i}}{Total \: Collateral \: in \: ETH
\:}LiquidationThreshold=TotalCollateralinETH∑Collaterali
inETH×LiquidationThresholdi
LIQUIDATION PENALTY

The liquidation penalty is a fee rendered on the price of assets of the
collateral when liquidators purchase it as part of the liquidation of a loan
that has passed the liquidation threshold.
LIQUIDATION FACTOR

The liquidation factor directs a share of the liquidation penalty to a collector
contract from the ecosystem treasury.
HEALTH FACTOR

For each wallet, these risks parameters enable the calculation of the health
factor:
Hf=∑Collaterali in ETH × Liquidation ThresholdiTotal Borrows in ETHH_f = \frac{
\sum{Collateral_i \: in \: ETH \: \times \: Liquidation \: Threshold_i}}{Total
\: Borrows \: in \: ETH}Hf =TotalBorrowsinETH∑Collaterali
inETH×LiquidationThresholdi
When
Hf<1H_f < 1Hf <1
the position may be liquidated to maintain solvency as described in the diagram
below.
Risk Parameters Safeguard Solvency
RESERVE FACTOR

The reserve factor allocates a share of the protocol’s interests to a collector
contract from the ecosystem treasury.
Aave’s solvency risk is covered by the Safety Module, with incentives
originating from the ecosystem reserve. As such, the Reserve Factor is a risk
premium calibrated based on the overall risk of the asset. Stablecoins are the
least risky assets with a lower reserve factor while volatile assets hold more
risk and have a higher factor.
COLLATERALS

USDT and sUSD have increased risk exposure due to the risk of a single point of
failure in their governance. Their counterparty risk is too high, both in terms
of centralisation and trust. For this reason, they cannot warrant the solvency
of the protocol. Accordingly, these assets are limited to be used as collateral
in Isolation Mode. On the other hand, agEUR and jEUR are decentralised; however,
these assets have little battle-testing and cannot be used as collateral.
Overall, stablecoins are used both for borrowing and as collateral, while
volatile assets, which many users are long on, are mostly used as collateral.
Hence, users of the protocol still benefit from the addition of these
stablecoins, and their risks are mitigated by the fact they cannot be used as
collateral.
FROM RISKS TO RISK PARAMETERS

Market risks have the most direct impact on the risk parameters:
LIQUIDITY

Liquidity based on on-chain liquidity and trading volume, is key for the
liquidation process. These can be mitigated through the caps and liquidation
parameters (i.e., the lower the liquidity, the higher the incentives).
VOLATILITY

Price volatility can negatively affect the collateral which must cover
liabilities and safeguards the solvency of the protocol. The risk of the
collateral falling below the borrowed amounts can be mitigated through the level
of coverage required through the LTV. It also affects the liquidation process as
the margin for liquidators needs to allow for profit.
The least volatile currencies are stablecoins followed by ETH. They have the
highest LTV at 75%, and the highest liquidation threshold at 80%.
The most volatile assets have the lowest LTV at 35% and 40%. The liquidation
thresholds are set at 65% to protect our users from a sharp drop in price which
could lead to undercollaterisation followed by liquidation.
MARKET CAPITALISATION

Market capitalisation represents the size of the market, which is key when it
comes to liquidating collateral. While the risk of assets with smaller market
capitalisations is more contained, it is often more volatile as these assets are
generally less mature. A higher market capitalisation, among other factors,
typically signals a more developed ecosystem (i.e., more liquidity on exchanges,
which enables liquidations with less of an impact on price). The market
capitalisation, along with liquidity, both on exchanges and on Aave, allow for
the quantification of liquidation risks. The liquidation parameters are
therefore adjusted to mitigate the risk of a high price impact liquidation for
assets with smaller markets (i.e., the smaller the market cap, the higher the
incentives).
OVERALL RISK

The overall risk rating is used to calibrate the Reserve Factor with factors
ranging from 10% for the less risky assets to 35% for the riskiest.
Asset Risk - Previous
Risks per Asset
Next - Asset Risk
Price Discovery

Last modified 2mo ago
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On this page
Risk Parameters Analysis
Supply Caps
Borrow Caps
Isolation Mode
Siloed Mode
eMode
Loan to Value
Liquidation Threshold
Liquidation Penalty
Liquidation Factor
Health Factor
Reserve Factor
Collaterals
From Risks to Risk Parameters
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Aave V3
Aave V3
Asset Risk
Introduction
Adding an Asset
Methodology
Risks per Asset
Risk Parameters
Price Discovery
Arbitrum
Avalanche
Fantom
Harmony
Optimism
Polygon
LIQUIDITY RISK
Introduction
Borrow Interest Rate
aToken Liquidity
External Audits & Analysis
Introduction
Formal Verification
Powered By GitBook