Protection Measures
Various methods for keeping collateral healthy and protecting in times of stress
Collateral Snowball ❄️⚪️ and "Seesaw"
Under normal conditions, protocol health is maintained through the collateral snowball and the "seesaw". More info on each of these can be found on the linked pages, though a short summary is described here. The collateral snowball refers to the fact that all $NUMA tokens—which serve as a representation of the collateral of the numa protocol—are backed at the current market price in rETH terms. Whenever someone burns or mints $NUMA through the vault or burns or mints for nuMoney, the rETH-backing of every $NUMA token in circulation increases. This means that even when tokens are sold, the price (collateral ratio) increases. Further, the backing increases when leveraged positions are opened, closed, or liquidated—or, whenever loans are liquidated.
Combined with this are the concepts of natural leverage and the "seesaw". A unique feature of the numa protocol is that when the protocol is healthy, the yield on synthetics is highest: the protocol is healthy when the ratio of synthetics to vault balance is low—e.g., there are 20 rETH worth of synthetics in circulation with 100 rETH in the vault. On the other hand, when the protocol is higher risk, the yield on synthetics is low: e.g., there are 80 rETH worth of synthetics in circulation with 100 rETH in the vault. This mechanism incentivizes users to unwind synthetics when the protocol is higher risk, since the yield is low.
Interest rate model
Under normal conditions, loans and leverage are interest-free. However, when the utilization rate reaches 80% of what we have deemed the maximum total borrowable amount, the protocol starts to charge interest on loans and leverage in accordance with the Fraxlend Variable Rate V2. The protocol requires an excess of 20% collateral in the vault beyond outstanding synthetic debt, which is the also the threshold where no new loans can be opened. The purpose of charging interest rates is to encourage users to repay their loans and restore the health of the protocol. For example, if there are 80 rETH worth of synthetics in circulation and 100 rETH in the vault, then the utilization is at 100% and new loans and leverage cannot be opened. However, interest rates start being applied at 80% of this level. For the purpose of applying interest rates, the following formula is used:
Utilization = rETH_borrowed / (rETH_cashAvailable + rETH_borrowed)
Such that,
rETH_borrowed = rETH borrowed by users and owed to the protocol
rETH_supplied = rETH deposited into the lending contract to borrow $NUMA
rETH_vault = rETH in vault
rETH_accountingBalance = rETH_vault + rETH_borrowed
rETH_maxBorrow = rETHAccountingBalance - synthetic_rETHdebt * 0.2
rETH_cashAvailable = rETH_maxVaultBorrow + rETH_supplied - rETH_borrowed
So, if we plug some numbers into the utilization formula, we can see how this works. Let's assume that 20 rETH has been borrowed from the protocol, 10 rETH has been supplied, 30 rETH is in synthetics, and 100 rETH are in the vault. Before we calculate the utilization rate, we have to find the rETH_maxBorrow and then the rETH_cashAvailable. In this case, rETH_maxBorrow represents how many more rETH are available to borrow before the utilization rate is 100%. For rETH_maxBorrow, we have:
100 rETH (rETH_vault) + 20 rETH (rETH_borrowed) - 30 rETH (synthetic_rETHdebt) * 0.2 = 114 rETH
Then, we can calculate the rETH_cashAvailable:
114 rETH (rETH_maxBorrow) + 10 rETH (rETH_supplied) - 20 rETH (rETH_borrowed) = 104 rETH
Lastly, we can calculate the utilization rate:
20 rETH (rETH_borrowed) / 104 rETH (rETH_cashAvailable) + 20 rETH (rETH_borrowed) = ~0.1613
So, in the given instance, interest rates are not being charged, since the utilization rate is ~16.13%. If the utilization rate reaches 80%, then interest rates begin to be applied in accordance with the Fraxlend Variable Rate V2. Again, the purpose of applying interest rates is to encourage paying back loans and forcing liquidations to restore the health of the protocol. These interest rates are applied to the pricing of the collateral of a loan, so that the profit margins decrease and liquidation prices increase.
Collateral protections
The numa protocol also employs other mechanisms at several thresholds to protect the collateral of the system. These thresholds refer to collateral factors that can be put in two categories: (1) the first (CF_liquid) tracks the ratio of synthetics to the vault balance, and (2) the second (CFTHEORETICAL) tracks the ratio of synthetics to the vault balance and the amount of rETH borrowed by users.
1) CF_liquid = rETH_vault / synthetic_rETHdebt
When the CF_liquid reaches 20%, the protocol prevents new loans or leveraged positions from being opened: this threshold is called WARNING. For example, WARNING would be triggered if there are 100 rETH worth of synthetics in circulation and 20 rETH in the vault. Remember that interest rates would have been applied up until this threshold to try to prevent the protocol from getting to this point. This threshold helps prevent the collateral position from getting worse.
The next threshold for CF_liquid is 5%; at this level, the $NUMA token sell_fee starts increasing at regular intervals. For example, this might happen when there are 100 rETH worth of synthetics in circulation and 5 rETH in the vault: in this case, the sell fee might increase 10% every 24 hours or 1% for every 2.4 hours. This would rapidly increase the collateral kept in the system that is used to back synthetics, since long positions use the vault sell price for liquidations: as the sell_fee lowers, liquidations occur, and the protocol accrues vault fees and liquidation fees—rapidly increasing the collateral position of the protocol.
2) CFTHEORETICAL = rETH_accountingBalance / synthetic_rETHdebt
As noted above, the rETH_accountingBalance includes both the rETH in the vault and the rETH that has been borrowed by users. When the CFTHEORETICAL drops to 110%, the protocol stops allowing new synthetics to be minted: this threshold is called WARNING. This might mean that there are 90 rETH in synthetics in circulation, 90 rETH in the vault, and 10 rETH borrowed—100/90 = 110%. Preventing the minting of new synthetics stops the problem from getting worse. Further, it allows the protocol to derate synthetics at the following threshold without arbitrage occuring to the nuMoney LP, thereby minting more synthetics.
Next, if the CFTHEORETICAL does not increase and continues to decrease to 105%, then the protocol begins to derate synthetics at 0.02 every 24 hours. This means that 1 $nuUSD will be treated as 98¢ after 24 hours and 96¢ the following day. So, users would only be able to redeem 1 $nuUSD for 98¢ worth of $NUMA and so on. By progressively derating over time, this provides forward guidance for users to unwind, since the synthetics will likely continue to be derated every 24 hours. As users unwind their nuMoney positions, the CF increases, since the synthetic debt decreases. If unwinding users hold onto $NUMA, this greatly helps the CF, since the reduction in the CF is direclty proportional to the amount of value that has been transferred from synthetic debt to $NUMA overcollateralization. Additionally, if the user decides to sell their $NUMA tokens, the collateral position of the protocol increases due to the vault fees.
Lastly, if the CFTHEORETICAL still continues to decrease to 101%, then the protocol will start derating synthetics at whatever rate is necessary to keep the CFTHEORETICAL above 101%. Further, the synthetics are debased an additional 10% beyond this rate. This could cause synthetics to rapidly derate, though it will be dynamic and should encourage people to leave synthetics and restore the health of the protocol. This also means that the value of the synthetic_rETHdebt is scaled for the purposes of pricing $NUMA, creating a price floor value. Further, the sell_fee also becomes dynamic to base_fee + (10*( 1 - syntheticDerate)) to stop users from extracting more value from the vault than its worth because of the clipping of $NUMA nominal price.
Summary of how protections work together
As described throughout this whitepaper—not only on this page—there are many mechanisms working together to protect the health of the system.
Under normal conditions—where interest rates and liquidity protections aren’t applied—there are several mechanisms that increase the collateral position which are summarized below.
Collateral Snowball
Minting $NUMA from vault
Burning $NUMA into vault
Minting or burning nuMoney
ETH volatility that requires arbitrage transactions through the vault
Synthetics volatility which requires arbitrage transactions through the vault and/or the burning and minting of nuMoney
Opening, closing, and liquidating loans and leverage
Seesaw
When the ratio of synthetics to vault balance is high and the protocol is higher risk, the yield on synthetics becomes low and encourages unwinding and restoring the health of the protocol.
In a similar manner, when the synthetics ratio is high, the leverage on the $NUMA token is high—which means it is a lot easier to drive the price up and should encourage speculation, which also helps restore protocol health.
Conversely, when the synthetics ratio is low, the protocol risk is low, and this encourages minting nuMoney, since the yield is high.
In times of stress, we have employed the mechanisms described above and summarized below—interest rates and liquidity protections.
Interest rates
Blocking new loans
Increasing sell_fee
Blocking new synthetics
Controlling synthetics pricing
It is important to understand the many levels of protection that have been implemented and also the way that they intentionally work together. These thresholds work together with the seesaw, such that yield decreases as interest rates increase as the $NUMA token gains leverage as the synthetics becomes derated as vault fees increase their efficacy in increasing collateral, etc. All of these mechanisms work together to maintain sufficient collateral in the protocol.
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