Counterparty risk

Over past year, the stablecoin space has seen the surge of the delta-neutral synthetic dollar category - stablecoins that are backed by such tokens as ETH and BTC, with price exposure hedged by short futures positions. Much has been discused about market risks of such products, with a lot of focus on funding rates volatility.

However, a less evident risk is the counterparty risk.

It is not only hard to model but also not something you can even easily solve by decentralization or diversification: you can diversify across multiple exchanges, but if one fails, the entire collateral pool—and the stablecoin’s peg—could be at risk.

True resiliency of stablecoin means preparing for the least expected. Achieving this resiliency comes at cost of building up the reserve fund. And this is not an easy task.

COUNTERPARTY RISKS EXPOSURE

But what is the risk exactly? Collateral is held outside of exhanges in third-party custodians, right?

Yes, margin can be safe. But there is another part. In case an exchange defaults, it may be the case that the futures position will have accrued profit. Money that the exchange owes to the trading entity.

How large can such amount be?

On 9 November 2022, FTX filed for bankruptcy. Combined drop in ETH prices over 8-9 November was 30%. Meaning that 30% principal amount of short futures at FTX would become bad debt.

FTX was an outlier, it may never happen again. How can we quantify counterparty risk in general?

A public example is Coinbase, a company subject to strict SEC oversight. It carries a BB- credit rating, indicating a 5% probability of default within five years. Exchanges operating in less transparent environment would have lower ratings - and higher implied probability of default.

HOW RESOLV DEALS WITH IT?

A stablecoin that has a 5% chance of depegging as a result of exchange default, will depeg, lose trust and eventually die if that event happens.

Resolv approaches the problem by establishing a protection layer - we call it Resolv Liquidity Pool. It is a separate pool that absorbs the risks first for additional reward.

Reward is the same, but its rate per $1 invested is different. The key benefit of such design is that RLP volume is self-balancing. When Resolv Liquidity Pool is thin, the stablecoin needs more protection, and RLP has higher yield, more attractive to market. And vice versa in cases when RLP amount is excessive.

WHAT'S NEXT FOR RLP?

Resolv Liquidity Pool has a unique risk profile - it serves as tokenized risk of trading venues. It makes a concept of RLP something bigger than just protection layer. What if we construct a separate RLP pool that will face a very specific risk, say, on Binance, making it akin to an on-chain perpetual bond?

This way, RLP allows you tokenize exposure to any entity (CEXes, DEXes, lendings etc.). You wish to take exposure to Binance? Welcome to the dedicated pool with higher yield! Want some diversification? Consider pooled exposure to several venues.

We are excited to imagine the ways it will be used.