From Nasdaq:

In the world of DeFi, risk management is crucial for sustainable lending protocols. Michael Bentley’s company Euler Labs serves as an example of the perpetual debate between immutable and governed code. The recent $200 million exploit on Euler v1 raised questions about the effectiveness of paternalistic risk management models.

Lending protocols must navigate complex risk factors like asset volatility and market arbitrage to determine optimal loan-to-value ratios. The most popular model today is global paternalism, governed by organizations like Gauntlet and Aave. This model sets conservative LTV ratios, but may not always be efficient due to governance delays and centralized decision-making.

On the other hand, the invisible hand model empowers lenders to actively choose risk/reward preferences in isolated pools. Protocols like Kashi and Compound v3 offer flexibility in LTV ratios based on free-market principles. However, this model faces challenges like liquidity fragmentation and high borrowing costs.

Aggregators like Yearn and MetaMorpho offer solutions to the drawbacks of isolated pools by providing passive access to diverse risk/reward opportunities. While aggregators enhance flexibility for lenders, they come with additional fees and paternalistic drawbacks. However, they do not fully address the challenges facing borrowers in fragmented markets.

Ultimately, to compete with traditional finance, DeFi needs a lending ecosystem with modularity at its core. Different protocol designs serve different user needs, and there is no one-size-fits-all solution. By leveraging modularity, protocols can offer highly customizable experiences that bridge the gap between monolithic governance and free-market principles.



Read more at Nasdaq: Risk Management in DeFi: Paternalism vs. the Invisible Hand