Risk Identification

Security risks are among the most critical risks in any DeFi protocol, particularly in the execution of smart contracts and the management of funds. The Likwid Protocol faces several key security risks:

• Smart Contract Vulnerabilities: Smart contracts form the foundation of decentralized protocols, and any vulnerabilities in the code can be exploited, resulting in the loss of user funds. To mitigate this risk, Likwid conducts rigorous code audits and third-party security testing. Every contract undergoes multiple rounds of comprehensive security audits before being deployed, aiming to prevent common vulnerabilities such as reentrancy attacks and buffer overflows.
• Governance Security: Likwid Protocol plans to introduce community governance in the future, and this process carries its own set of security risks. If governance mechanisms are maliciously exploited, protocol parameters may be altered, potentially compromising the integrity of the entire protocol. To address this, Likwid has introduced a multisignature mechanism and is gradually transitioning to decentralized governance to ensure transparency and security throughout the governance process.
• External Dependency Risks: Although Likwid does not rely on oracles to avoid price manipulation risks, the protocol interacts with other DeFi components such as liquidity bridges and cross-chain support, which can bring additional security vulnerabilities. Therefore, the protocol conducts stringent security tests and reviews for all external integrations to ensure that they do not pose threats to the overall security of Likwid.

Risks Associated with Delayed Liquidation of Collateral

In Likwid Protocol, derivatives traders collateralize base tokens and borrow target tokens from the liquidity pool for short-selling operations. After liquidity is added, it cannot be withdrawn immediately; the funds will be locked in the smart contract for 30 seconds before becoming withdrawable.If the value of the collateral falls below the set liquidation threshold, the system triggers a liquidation process. However, if the liquidation cannot be performed in a timely manner, it may pose risks to both the protocol and liquidity providers:

• Delayed Liquidation Risk: Due to severe market volatility, the value of the collateral may rapidly decrease. If the protocol cannot liquidate the collateralized position promptly during a sharp price drop, it may result in insufficient liquidity in the pool, potentially jeopardizing the safety of liquidity providers' assets.
• Insufficient Liquidity Risk: In extreme market conditions, the liquidity pool may lack sufficient funds to carry out the liquidation process. This lack of liquidity directly affects the successful execution of liquidation. If the value of the collateral is insufficient to cover the borrowed amount, the protocol could fall into a deficit, becoming unable to fully compensate liquidity providers.
• Negative Impact on Prices: Due to the relationship between the synthetic token y′ and the target token Y in Likwid Protocol, if derivatives traders are unable to repay borrowed funds in time, it may lead to an imbalance in the supply-demand relationship between the synthetic token and the target token, thereby affecting the price of the target token. This imbalance could further exacerbate price volatility, increasing liquidation risk.

To mitigate risks associated with delayed liquidation, Likwid Protocol has implemented the following measures:

1. Automated Liquidation Bots: Likwid deploys automated liquidation bots that continuously monitor the health of every collateralized position. When the value of the collateral approaches the liquidation threshold, these bots automatically trigger the liquidation process, ensuring timely liquidation and preventing delays.
2. Liquidity Reserve Pool: In the future, the protocol will maintain a liquidity reserve pool to provide additional liquidity during extreme market conditions. This reserve pool will be funded by protocol revenues and a portion of trading fees, serving as an emergency source of liquidity to ensure that liquidation can proceed smoothly even when overall market liquidity is tight.
3. Price Volatility Protection Mechanism: To mitigate risks arising from extreme market volatility, Likwid plans to introduce a price volatility protection mechanism. In situations where prices fluctuate rapidly, the system will establish a short-term price protection mechanism to ensure that liquidation processes are not abused during extreme price swings, thus protecting liquidity providers from losses.