Risks Outline
This page documents all of the known potential risks associated with the Protocol as well as the steps Solid World has taken in order to reduce them as well as possible.
Non-Delivery
Projects may under-deliver or fail to deliver completely. As outlined in the previous chapter on Due Diligence and De-risking, there is a multi-step process in place to minimize these risks. Non-delivery procedures are specifically outlined in their own chapter.
That being said, some non-delivery might still happen. While small non-deliveries are unlikely to affect the structural stability of the system, complete collapse on the part of Supply Partners does pose a significant risk. This is why screening Supply Partners is important.
Furthermore, there are some limits being considered in order to reduce structural exposure such as:
Setting a percentual limit on how much of a Collateralized basket can contain Forward Clips from a Project, additionally taxing or completely closing off further deposits until the balance has been corrected.
Setting a percentual limit on how much of a Collateralized basket can contain Forward Clips from a Supply Partner, additionally taxing or completely closing off further deposits until the balance has been corrected.
If such limits are instituted by Solid World, delegating a role that would adjust these limits based on ongoing monitoring of Projects/Supply Partners.
Market Turbulence and Illiquidity
If market conditions turn drastically optimistic or drastically pessimistic, Concentrated Liquidity positions such as those described in the chapter about Collateralized Basket Tokens can make either buying or selling CBTs impossible for some period of time.
Upper bound scenario: If the market for a specific CBT becomes overly exuberant, raising the price of CBTs to the upper bound of the Concentrated Liquidity position, further buying of CBTs becomes impossible, as the DEX has run out of CBTs to sell. This opens up the opportunity for Projects and Supply Partners to bring in more Forward Clips into the system, deposit them into the Basket and liquidate the resulting CBTs into the AMM.
Lower bound scenario: If the market for a specific CBT becomes drastically suppressed, raising the price of CBTs to the lower bound of the Concentrated Liquidity position, further selling of CBTs becomes impossible, as the DEX has run out of stablecoins to exchange for. This opens up the opportunity for Projects and Supply Partners to remove some of their Forward Clips from the system, closing an arbitrage opportunity from having brought in supply at a higher price and having removed it at a significantly lower price. Additionally, this makes other Market Participants able to buy Forward Clips at a discounted rate, causing buy pressure for the CBT.
Price Spread within Basket
As was observed in the original Toucan implementation of combining spot carbon credits (within their terminology referred to as 'Pooling') into ERC-20 tokens for liquidity: this approach generally has the rather undesirable effect of only ultimately creating liquidity for the cheapest applicable asset. This also causes more valuable assets within the structure to gravitate out of the pool, if such liquidity exists. This is driven by the ability to arbitrage the value differential of the "generic" versus the underlying "specific".
While Solid World Protocol's Baskets can experience a similar outcome, this is drastically limited by Solid World curating a Basket's entry criteria on a project-by-project basis. This allows for more fine-grained control over which projects the Basket is providing liquidity for. The Basket's criteria are based on observing market conditions around these criteria in order to find groups that currently trade at a similar range and have few reasons to continue doing so. This means that, for example, forward offtake agreements related to different registries are unlikely to be put into the same Baskets, as registries might adopt different policies and attitudes, which can affect the value of their carbon credits.
Even so, if there are shifts within the voluntary carbon market, such as new developments to how COP26 Article 6 is applied to the voluntary market, this might cause price fragmentation within even a single class of carbon credits. In order to minimize this, Projects are expected to have signed letters from their local governments affirming that their supply would be provided a Corresponding Adjustment, if relevant.
Impermanent Loss
Liquidity Providers who provide CBT/USDC liquidity on DEXes for the various Baskets are exposed to a particular risk referred to as Impermanent Loss. When the price of a CBT goes up, Liquidity Providers automatically sell CBT. When the price of a CBT goes down, Liquidity Providers automatically buy CBT. Impermanent loss is a loss in value compared to holding the underlying CBT and USDC. This sort of loss increases as the exchange rates between the USDC and the CBT diverge from the starting point.
In order to counteract these losses, the Protocol provides the Liquidity Providers with Rewards through the mechanisms described in the Liquidity and Rewards chapter. Additionally, as carbon credits are not as volatile as cryptocurrencies, the likelihood of seeing drastic, sustained price swings is lower. The market is capable of arbitraging large price swings in order to dampen the effects of Impermanent Loss.
It should finally be noted, that compared to normal Constant Function Market Makers as discussed in the Collateralized Basket Token chapter, Impermanent Loss is amplified for Concentrated Liquidity positions. This is because the exchange of one side of the trading pair to the other happens faster.
If the market observes a prolonged period of price change, Solid World may shift the Concentrated Liquidity trading range in order to better facilitate the market. While this can "lock in" Impermanent Loss to some extent, it also makes the underlying position better able to continue its work.
Smart Contract Exploits
With blockchain applications, there is always some risk of the associated smart contracts being exploited in some way. Major exploits, however, have generally happened to decentralized applications which have not been audited. Solid World will not release un-audited code onto the blockchain, which has not been properly vetted by a third-party auditor.
Additionally, Solid World commits to not integrate with any third-party contract, which has not been audited by a reputable third-party auditor as well.
These two steps have been shown to significantly minimize the risk of exploits occurring.
Broader Shifts in Voluntary Carbon Market
Due to sentiment, demand, supply, regulations, inter-governmental agreements, and a host of other factors, the value of carbon credits can fluctuate, potentially dramatically. While there are many documents outlining the expected growth of the Voluntary Carbon Market as organizations become more and more incentivized to offset their carbon footprint - this is not guaranteed. Having exposure for forward offtake agreements for carbon projects carries the price exposure to carbon credits as well.
Legal and Regulatory Risks
While Solid World has a non-binding opinion from both of the Estonian government institutions concerning the legal status of the protocol and its associated assets, these opinions might change over time as a result of new laws. The Solid World Foundation is consistently monitoring these shifts and working with the Estonian branch of PwC in order to navigate the broader regulatory landscape.
The legal designation of Foward Clips as well as Collateralized Basket Tokens as utility tokens may change, broadening the requirements for KYC and AML practices for example. Solid World will aim to be in compliance with whatever requirements are imposed on it by regulators.
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