Liquidity Risk
Breakdown of liquidity risk on Moonwell
Definition
Liquidity is a measure of how easily an asset can be traded for another. By managing liquidity risks, we maximize the likelihood of liquidations working seamlessly.
Risks
Protocols like Moonwell are also subject to liquidity risks.
If an account collateral ratio breaches the minimum collateral ratio enforced by the protocol it will become eligible for liquidation. In order for liquidators to be able to liquidate assets at a reasonable price there must be sufficient on-chain liquidity for liquidators to liquidate accounts profitably. If an account can’t be liquidated successfully because liquidity is constrained, the protocol won’t be able to effectively mitigate its exposure to a given asset’s price volatility.
The protocol is also subject to market liquidity risks since mTokens used as collateral need to be redeemed when a flash liquidation occurs. In order for mTokens to be redeemed to underlying Moonwell markets must be sufficiently liquid (i.e. utilization has to be below 100%).
Indicators
For our methodology we’ll use the following data points to assess an asset’s liquidity profile:
DEX liquidity: Amount of dex liquidity (TVL) on pools that trade the asset and efficiency of those pools (i.e Uniswap v2 vs v3, stable pools)
Slippage - Difference between the spot price and implied price of a given trade size. Slippage varies depending on trade size, dex liquidity and pool efficiency.
Market utilization - On Moonwell, in order to borrow, collateral must be supplied. However, when markets reach maximum utilization, supply positions can’t be withdrawn. This poses a risk of not being able to liquidate positions in over-utilized markets in the advent of high-volatility periods.
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