Index risks explained

Low-risk scenarios

Strategy yield diminishes

Yield-bearing strategies tend to have unsustainable returns, as most of them are based on external yield farming incentives. Within a protocol, incentives are often reallocated to different pools depending on voting round results. Either that or a pool stops receiving incentives altogether.

In case a strategy stops receiving incentives or yield drops to unsatisfiable levels, the team would either exit the strategy, reallocate funds to other strategies, or implement a new strategy and add it to the index.

Strategy underlying pool TVL drop

Liquidity tends to move from pool to pool quickly. It can happen either because liquidity providers find a more profitable opportunity elsewhere or if liquidity providers deem a particular strategy too risky.

In case of strategy, TVL drops significantly, the Locus team will research to see if there are any significant risks, if there is something wrong with the protocol, the Locus team will either exit the strategy or reallocate funds to other strategies while searching for alternatives.

Medium-risk scenarios

Underlying asset depeg

Many strategies utilize “wrapped” assets, such as ETH derivatives, stablecoins, or other derivatives. These assets oftentimes rely on external liquidity pools and can not be redeemed into base assets easily. These liquidity pools can sometimes go out of balance, resulting in reduced liquidity and panic selling of a derivative asset by a wider crowd to avoid further losses.

Each case should be assessed individually by identifying the root cause first and executing later. By successfully identifying reasons for a particular asset losing its peg, the Locus team can avoid unnecessary losses by withdrawing strategy funds to the withdrawal buffer.

Oracle manipulation

Strategies utilizing leverage are dependent on oracles functioning properly. If a specific oracle used by a protocol malfunctions, leveraged positions can be at risk. Depending on which oracle is used in a particular strategy, the action plan to prevent such attacks will be different.

High-risk scenarios

Protocol exploit

This is a very broadly defined scenario, which will differ greatly from strategy to strategy. Preparing for each exploit is impossible, as the potential attack vectors are limitless, especially with the amount of different strategies utilized even in one index. The Locus team assesses potential attack vectors before adding a particular strategy to the index, however, exploits can never be completely mitigated. Depending on a particular index risk level, security could also be compromised to favor above-market returns.

As exploits usually happen instantly, leaving most users unprepared, the ideal solution is a third-party service able to identify and prevent potential attacks. Examples include Pessimistic, Forta, or Peckshield automated attack prevention solutions, however, none of them have been selected so far.