Risk and Risk Mitigants

A description of the risks and how the protocol mitigates the risks.

Risk and mitigations

Defi vaults are experimental and complex. The protocol will adjust its design based on usage and observations to ensure that risk and incentives are adequately balanced.

One risk involves other protocols. As defi vaults are strategies that are reliant on the yield and smart contracts from other protocols, any hacks or security breaches in that protocol will have a direct impact on the Baklava Space vaults. Baklava Space mitigate this by using protocol that has passed the security audits.

The other risk is that in certain vaults such as leveraged vault, there are risks that in the event of a large market price movement, the principle sum may be liquidated to cover the borrowing. To mitigate this risk, the protocol has done extensive backtesting to ensure that the leverage vaults are not over-leverage.

Backtesting

Back testing is a tool the protocol used as a risk mitigation to assesses the viability of a strategy by understanding how the strategy would have played out based on historical data.

The underlying theory is that any strategy that worked well in the past is likely to work well in the future, and conversely, any strategy that performed poorly in the past is likely to perform poorly in the future. The risk of this underlying theory is that past performance is not a perfect indication of future performance.

When testing a strategy on historical data, we are mindful that the period used for historical data may not cover the full market cycle of market ups and downs. For example, testing on historical data based on a market up cycle may not reflect the performance of the strategy under a market down cycle. Therefore, we understand the limitations of backtesting, and it is used as one of the tools to understand where are the risk parameters under the best and worst scenarios.