We consider five types of risks for our interest rate product, namely: protocol risks, smart contract risks, and impermanence loss risks.
Protocol Risks refer to risks associated with the protocol or protocols our interest rate product relies upon for operations (tech risk, counterparty risk, and liquidity risk).
Smart Contract Risk - Smart contracts may be susceptible to security breaches and improper administration. Participant organizations or network administrators will need strong governance and change control processes to deploy new or amend existing smart contracts. They will also need a robust incident management process to identify and respond to glitches in smart contract operations.
Market Risks refer to risks associated with the underlying assets or investments in a DeFi product. These risks include price volatility, liquidity risk, and counterparty risk. Price volatility is the risk that the price of an asset may fluctuate widely, resulting in significant gains or losses for users. Liquidity risk is the risk that there may not be sufficient liquidity in a DeFi product to execute transactions at the desired price.
Counterparty Risk is a significant concern in the DeFi space and applies to GLP as well. As the GLP pool is the counterparty to traders, there is a risk that the pool may fail to fulfil its obligations, leading to losses for traders. For instance, if the pool is unable to cover the profits made by traders, the remaining traders may face losses. Additionally, there is a risk of hacking or security breaches, which can lead to funds being stolen from the pool, and ultimately affecting the value of the GLP tokens. Moreover, there is a risk that the GLP tokens may be affected by the security of the bridges used to transfer funds or the pegged tokens used in the protocol. Therefore, counterparty risk is a crucial consideration when investing in DeFi products such as GLP.
Impermanent Loss which is a temporary loss of funds occurring when providing liquidity. In our specific interest rate product a potential impermanence loss is first absorbed by the junior tranche (variable yield) before it trickles through to the senior tranche (fixed yield) if any.