Volatility Risk
Breakdown of volatility risk on Moonwell
Definition
Volatility can be described as a measure of the amplitude of price changes for an asset over time.
Risks
Overcollateralized lending protocols like Moonwell are subject to volatility risks. As collateral and debt asset prices change, the collateralization of accounts changes.
In order to maintain solvency, the protocol must ensure that debts are always overcollateralized by assets of a higher value. If debts were not overcollateralized, borrowers would be economically incentivized to default on their debt. Defaulting would lead to the creation of bad debts in the system.
In order to mitigate asset volatility risk, the protocol enforces liquidations to ensure that debts are always overcollateralized.
Indicators
For our methodology we’ll use the following data points to assess an asset’s volatility profile:
Historical volatility - Past volatility can be a good indicator of future volatility
Historical drawdowns - Past worst asset decrease over a given period of time
Asset concentration - Wallets who hold a sizable portion of the total supply of the asset also have a sizable capacity to influence its price.
Asset liquidity - Deeper liquidity can decrease an asset's volatility.
Peg and collateralization - If an asset is pegged (ex: USDC) it will change its volatility profile.
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