Allocation Process

The primary focus for any onchain allocation is to avoid exposing users to markets where collateral is exposed to idiosyncratic risks or volatile price action.

Principal loss (or bad debt in the case of onchain repo, e.g. Morpho) in a market is generally preceded by a downward price movement in deposited collateral (e.g. cbBTC), as reflected by a market’s chosen oracle, below a price implied by the market’s LLTV. At this stage, liquidators - generally bots or sophisticated market participants that “listen” for profitable arbitrage opportunities - can buy the collateral out of the market, satisfy lenders at par, and pocket an incentive fee. If the downward price movement is sudden and severe, however, the liquidator may not purchase the deposited collateral at a price that satisfies lenders at par, resulting in the loss of lender principal.

Even with very low historical default rates on overcollateralized crypto repo lending, Steakhouse expends significant resources to underwrite and mitigate the risk of undercollateralization, liquidation, and illiquidity along the following vectors:

Credit risk:

• Issue: A deposited asset suffers a credit impairment (e.g. loss of asset collateralization), triggering a potential undercollateralization of a lender’s position

• Mitigant(s): Asset selection process and suitability for the intended customer profile, automated solvency and 24/7 price monitoring, and direct connectivity to asset issuers

Counterparty risk:

• Issue: The “management team” behind a deposited asset acts nefariously and against the interests of their tokenholders

• Mitigant(s): Only lending to sufficiently decentralized or regulated collateral (i.e. steakUSDC); deep underwriting of issuer’s team, signer process, and operational controls

• See: Collateral Standards

Liquidity risk (for a deposited asset):

• Issue: Limited secondary liquidity for a deposited asset, particularly across distressed market regimes, resulting in higher risk of severe negative price action

• Mitigant(s): Historical liquidity and venue analysis for selected assets, 24/7 liquidity depth monitoring and forecasting, and deep relationships to source OTC liquidity if necessary

Oracle risk:

• Issue: Compromised oracle asset feed triggers an incorrect liquidation due to basis risk (wstETH/ETH), improper updates, and/or hard coded oracles

• Mitigant(s): Deep expertise with oracle configurations, backup and failsafe oracle procedures, and primary rate oracles for issuers with primary redemption at par

Smart contract risk:

• Issue: Unforeseen risk in the underlying protocols (e.g. Morpho), upon which the individual borrow/lend markets are deployed

• Mitigant(s): Deep in-house technical knowledge and competency to perform proprietary audits, usage of platforms with minimal code (i.e. minimal surface area for attack), and requirement of multiple third-party auditors (10 instances for Morpho & Morpho Vaults)

Liquidity trap risk (market):

• Issue: Insufficient market utilization, leading to artificially low “borrow rates” that do not sufficiently disincentivize borrowers to pay withdrawing lenders back

• Mitigant(s): Conservative market listing procedures (e.g. typically “second-movers” to more aggressive curators or “first-movers” after extensive underwriting and due diligence) and minimum target borrow rates.

Before listing any market, at least 2+ members of the Steakhouse risk management team perform an asset and market configuration quality control process.

Deployments

Automated and robust deployment pipelines help minimize the risk of manual errors or misconfigurations. For instance, our Morpho Market Factory performs automated checks on certain key market configuration parameters (latest version here). This process helped us identify a market with a misconfigured oracle (0.97 vs. 0.94 starting price) but was listed by less experienced curators, whom we alerted to the case.