DeFi Score: Assessing Risk in Permissionless Lending Platforms

With this year’s DevCon in Osaka being strongly focused on the rise of DeFi, it should come as no surprise that Consensys engineer Jack Clancy used his platform on the conference’s main stage to shine light on DeFi Score, a framework to grade permissionless lending applications.

In light of the recent announcement of the Crypto Asset Council, the launch of DeFi Score in late September marks the rise of an emerging interest for reputable service providers to propose a standardized rating system to further categorize top digital assets. In this sense, these tools aim to provide users with a high-level overview of the risks associated with different assets.

By using DeFi Score, it can become clear why an asset may have a higher lending APR on a platform like Nuo over something like Compound. Stated another way, the inherent risks associated with different platforms are by no means viewable to an average user, implying that a service like DeFi Score can be a valuable tool for identifying which platforms may require more caution.

How are Ratings Determined?

The methodology for assessing risk is based on a scale of 0-10.  The most popular asset types (DAI, USDC etc.) are rated relative to the platform(s) they are being used on. A score of 10 is best, otherwise stated as an asset that has no risk. On the flip side, a score of 0 indicates a significant degree of risk and that the asset (or platform) should be avoided at all costs. In particular, grading is broken down into the following categories:

1. Smart Contract Risk (50%)
   1. Audited code (25%)
   2. All code’s byte source verified (15%)
   3. Formal Verification (5%)
   4. Bug Bounty Program (5%)
2. Financial Risk (35%)
   1. Collateral Makeup / Collateral Value at Risk (CVaR) (10%)
   2. Collateralization Ratio 30D EMA (15%)
   3. Liquidity 30D EMA (10%)
3. Other Considerations (15%)
   1. Insurance/Regulatory Risk

Existing Ratings

As it stands today, DeFi Score has currently incorporated four different lending platforms into their platform. At the time of writing, Compound Finance, dYdX, Fulcrum (bZx) and Nuo (Nuo Network) or currently listed alongside seven popular DeFi assets: DAI, USDC, ETH, WBTC, REP, ZRX and BAT. To summarize the current scores, Compound currently holds the highest grade while Fulcrum is listed as most risky. As time goes on, one can expect the number of platforms and ratings to be gradually increased.

Seeing as Compound is currently the largest provider on the list of supported platforms, it should come as no surprise that their system has the highest score. Furthermore, a formal audit by Open Zeppelin serves as a strong representation of the mitigation of smart contract risk (the highest influence on score).

Setting The Stage

While DeFi Score presents a step in the right direction, it is by no means comprehensive. The team has been very vocal that these are merely their opinions and by no means represent factual information from the industry at large. Similarly, This model does not consider many other risks that are relevant to these products, such as oracle risk, centralization risks and liquidation policies. When asked about the grading policy via the official DeFi Score Telegram, community members noted that:

“The weights of the individual components that contribute to a score are somewhat arbitrary (and open for review!). The ecosystem is moving fast and it’s tough to quantify risk – it is a moving target. This flexibility lets us compare the landscape today on the 10 pt scale. I don’t think we’ll see a perfect 10 in the near future as there are risk attributes that no one has completely addressed, and I’m sure new ones will be added over time.”

Conclusion

It’s important to recognize that the team behind this project is presenting a strong framework with an ever stronger ethos. As DeFi continues to grow, it becomes increasingly important for consumers to know which platforms they can trust. As the ecosystem becomes more and more complex, it only seems logical that growing support and interest in a standardized rating system would be a fantastic way to garner the interest of more serious institutional players.

DeFi Score is entirely open-source and always looking for new contributors. To learn more about the project, please reference the official Github which also contains a link to the full whitepaper. In the meantime, be sure to stay up to date with new progressions via the official Telegram. An active list of score will always be live at defiscore.io. We look forward to hearing from you!