Risks and Mitigation Plans
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Logical bugs
Technically, even a minor programming error in protocol development can lead to numerous exploits. When occurring in blockchains where immutability underpins the system, it means unrecoverable financial losses. To mitigate the risk due to the logical bugs, a comprehensive smart contract audit service is highly regarded as one way to detect potential vulnerabilities. There are also program analysis tools available in the market that detect known or recurring exploit patterns.
Flash loans
Flash loans are a unique instrument in DeFi space that allows borrowers to borrow an unsecured loan without any third-party intermediary. This is made possible by the fact that flash loans are instant i.e. the capital is borrowed and repaid in one transaction. Driven by smart contract rules, they can be made collateral-free. Flash loans hence give attackers unlimited free leverage. The attackers may utilize flash loans to manipulate the price of assets held by a fund portfolio and simultaneously interact with our protocol to reap the benefit of the distorted prices. Since Avareum's protocol operates in a sequential and non-atomic way to facilitate cross-chain transactions, such exploits cannot be performed without taking absolute control of the market.
Data oracle
Oracles are service providers that connect outside information to smart contracts. The use of oracles is to feed the market prices from several exchanges or service providers to Avareum protocol. The manipulation of oracles can be catastrophic harm to the protocol e.g. incorrect NAV calculation. Avareum's solution is to utilize multiple sources of price feed and build a consensus on the reference price in order to mitigate the risk of price manipulation.
Transaction ordering
Front-running a transaction refers to submitting a transaction that is solely intended to be executed before some other pending transactions. An agent may financially benefit from front-running one or more transactions, by having their transaction executed before a victim transaction. This can be done by detecting an exploitable transaction and bidding a higher transaction fee to obtain execution priority. Protecting against this is difficult as it would come down to the mechanism of the underlying blockchain. Our implementation is designed to reduce the incidence of front-running by issuing smart-contract-wrapped transactions. See for more details. The diverse form of transactions acts as camouflage, hiding it from straightforward detection and front-running attacks.
Other technical vulnerabilities
Examples of protocol exploits concerning technical security include, but are not limited to, reentrancy, integer manipulation, displacement attacks, etc. These attacks reveal specific exploitable patterns that are well known to the developer community e.g. Consensys guidance, Swcregistry. Our developer team follows most, if not all, of the smart contract vulnerabilities and anti-patterns that are known up to date.
Draining attacks
In traditional asset management, execution costs at subscription and liquidation at redemption, e.g. transaction fees, slippages, are absorbed into the existing asset under management (AUM). Excessively depositing and withdrawing, if done enough times, can drain the funds at the expense of other investors. Integrated into the core design, our bid-ask mechanism protects the funds of other investors by compensating for the execution costs they are expected to absorb. See for more details.
Interconnection with traditional finance
Several dollar-denominated tokens that circulate on blockchains are backed by dollars at financial institutions. This in turn introduces dependencies on the issuer of the underlying instruments and the institutions where the dollars are reserved. Therefore, financial insolvency, regulatory actions, and failures of the issuer are likely causing the stable coins to be traded at a discount or premium to par or maybe un-redeemable. Investors should take serious caution that custodial stablecoins, such as USDC and USDT, are mainly used as the denomination assets in many of the Avareum funds.
Despite going beyond Avareum's operations and controls, fund managers may foresee the potential risks and perform portfolio rebalancing to protect the fund in a specific way. The mitigation decision solely depends on the analysis and judgment of the fund managers in order to follow her contingency plan, if any.
Composability Risks Composability property offers potential for constructing complex and interconnected financial systems, yet bears the danger of exposing agents to composability risks, which are mostly unquantified. These risks particularly concern the execution which operates in conjunction with one or more protocols and services on both the same and different operated chains. In moderate failures such as occasional transaction errors, we partially mitigate the risks using a smart-contract-wrapping design. This allows us to skip any asset that causes failures and continue with the rest of the operations. See for more details.
The Avareum protocol may be subject to a risk of contagion of systemic defaults in the DeFi ecosystem, as more complex token wrapping structures stimulate a higher degree of protocol interconnectedness. Moreover, upgrades and maintenance of the relevant protocols entail additional risks. These risks are beyond our scope and controls.
Risks from the underlying technologies
All of DeFi applications rely on the underlying blockchains such as Ethereum Chain, Binance Smart Chain, etc, the functionality of which cannot be guaranteed. Likewise, Avareum protocol is inevitably subject to failures of the underlying technologies. Examples of blockchain failures include consensus failure, interventions, miner extractable value (MEV), validator cartels, and bugs such as inflation bugs.
Administrative key abuse In Avareum protocol, we do offer administrators a discretionary option to pause, upgrade, shut down the protocol via admin keys. The existence of the keys, however, raises a number of risks such as key loss, hacks from an outside party, insider theft, and regulatory pressure. Without secure key management, it opens vulnerabilities to malicious actors to compromise the protocol. Avareum's solution is to grant a consortium of delegates control over critical smart contract decisions via multi-signature arrangement. Moreover, smart contracts are enforced with timelocks on the key-related decisions.
Governance manipulation
Via a decentralized governance mechanism, the protocol empowers governance token holders to purpose and vote upon upgrades and configurations. The technical structure of the governance mechanism may nevertheless be exploited. For example, controversial proposals, monopolized approvals, or immediate protocol upgrades may affect investors' investment plans. We employ 24-hour timelocks in any governance process so that other participants still have a chance to react.
Regulatory uncertainty
Asset management is strictly regulated in traditional finance through registration, license, and mandatory inspection. Although intermediaries are excluded in favor of transparent code in decentralized finance, uncertainty in regulatory rules may be enforced in the future.