UNION

UNION (UNN) is a technology platform that combines comprehensive security and a liquid secondary market with a multi-token model. DeFi participants manage their multi-layered risk through smart contracts and protocols in one scalable system. UNION lowers entry barriers for retail users and lays the groundwork for institutional investors.

The UNION token model is designed for success and scalability using a layered model with a clear separation of functions for each token:

UNN - control token;

uUNN security policy token;

PUNN protection pool token.

Governance tokens and protection tokens are separated to prevent conflicts of interest and to separate governance from the market dynamics of buying and record protection.

UNION is a technology platform that combines comprehensive security and a liquid secondary market with a multi-token model. DeFi participants manage their multi-layered risk through smart contracts and protocols in one scalable system. UNION lowers entry barriers for retail users and lays the groundwork for institutional investors.

What separates the line between Las Vegas and Wall Street is not necessarily the risk-taking that both enjoy; it is an understanding of the degree of perceived risk and adequate management of probabilistic outcomes.

Risk management is all around us, from simple decisions to complex financial investments. We use risk/reward models for almost every decision we make in life, subconsciously or consciously, regardless of the material done or the reward or punishment that results.

Smoking can put you at risk for cancer or heart disease, resulting in higher levels of financial risk and lost work years, as well as higher insurance premiums. A stock speculator can buy a call or put option to limit his position. A man in a casino can adjust the size of his position depending on the distribution of cards.

Digital asset markets are introducing unique risk classes. Trusted intermediaries providing services such as escrow or execution are kept to a minimum. In exchange for this efficiency, investors take on the underlying and associated risk that DeFi participants face, which ranges from traditional counterparty risk to the daunting threat of smart contract vulnerabilities, and more.

Ethereum's seamless, transparent financial ledgers are a melting pot for both economic and technological innovation. The result is an open arena of co-op play between stimulus-focused protagonists and malevolent antagonists. Ethereum is the Dark Forest.

Risk management in cryptography is both an unprecedented challenge and an opportunity.

What was once fervent retail speculation to inject money into altcoins has become more significant in 2020. The introduction of DeFi platforms, ranging from borrowing/lending protocols to DEXs, synthetic assets, and insurance mutual investments, has spurred research towards better risk management. It is more than possible that we are entering a new wave of financial innovation after the securitization market in early August, the bond markets of the eighties and the mass digitization of Wall Street.

If traditional finance is 80 percent people and 20 percent technology, and fintech is 20 percent people and 80 percent technology, then DeFi is 100 percent technology.

The focus on technology is what makes DeFi exciting, but it also creates challenges. The tactics currently used to make money in DeFi are out of reach for the average person, high risk, and costly in terms of gas costs on the Ethereum network.

In this “DeFi summer”, the market is faced with the following question:

How to properly manage risk in a composable DeFi stack?

Risk in DeFi is different for several reasons. The non-custodial nature of its lending platforms, volatility in token prices, on-chain vulnerabilities including unique mempool transaction reordering threats, and nuanced user behavior can be broadly summarized into two main types of risk:

Technical risk;

economic risk.

It is important to note that technical risk has never been completely separated from price risk in the digital asset market. A prime example is the YAM fiasco, where a bug in a rebase contract interfered with the proper functioning of the management process, creating insane timelines for users to safely withdraw funds. The price of the YAM token simultaneously fell within a few hours.

The technical risk faced by DeFi is unique and includes a wide range of vulnerabilities. These include smart contract bugs, first-level attacks (such as 51% attacks), and an increase in MEV-related issues such as running a mempool to the forefront with generic arbitrage bots. These risks are specific to permissionless blockchains, where anonymous users can explore weaknesses in production code and exploit bugs at will.

Technical risk includes an excess of vulnerabilities faced by user deposits on DeFi platforms such as Compound, Aave, Maker, and others, which collectively hold billions in total value locked (TVL).

Some of the more prominent recent examples include the use of the Opyn ETH put option and bZx's smart financial engineering using instant loans. One of the most egregious technical feats was the recent penetration of ETH into the Eminence (EMN) smart contract by risk-blind DeFi users, which subsequently led to the attacker losing $15 million of the contract. Interestingly, one of the positives of the EMN exploit that allowed the hacker to return half of the funds (creating the #halfrekt viral trend on CT) was that community involvement in risk management and insurance increased tangibly.

The predominant defense against technical exploits at the smart contract level is rigorous auditing by respected firms in the industry, private disclosure of vulnerabilities, and bug bounty.

However, auditing, bug bounty, and responsible disclosure are not a panacea for technical exploits in a system without permissions. The code is constantly evolving to scale and meet user requirements, opening up new and unknown attack vectors as the network evolves.

Insurance platforms like Nexus Mutual have fallen into the void to provide pooled insurance coverage for smart contract vulnerabilities. The first claim formally paid to Nexus Mutual was the aforementioned bZx loan attack, which resulted in approximately $31,000 being paid out to claimants by mistake by bZx Fulcrum.

Others, such as Tidal Finance, have even introduced programmable insurance pools using a Balancer-like market for various Tier 1 chains other than Ethereum. However, the coverage is discretionary and technical exploits can go deeper than the smart contract level, reaching both the mempool and the chain level.

In particular, mempool-related vulnerabilities have been gaining momentum since the publication of Flash Boys 2.0, which highlights the MEV and PGA of arbitration bots. The talk was soon followed by Dan Robinson's account of how Ethereum is the Dark Forest, which was later outlined by famous security developer Samchsun's attempts to escape the Dark Forest.

The mempool threat theater is new and shows how the open Ethereum ecosystem will constantly create unknown technical risks that need to be addressed in the future.

The variety of technical vulnerabilities at different levels of DeFi highlights the need for more sophisticated risk management. Current insurance options and smart contract solutions (such as audits) address technical risks only piecemeal, rather than bundling more comprehensive insurance together.

Technical risks are not strictly limited to one layer. Sometimes they are combined into versatile attempts at hidden behavior, which, once discovered, seem to be ingenious. There are fail-safe systems such as MakerDAO's MKR governance options auctioning the token on the open market to stabilize the CDP, but questions remain about how quickly such actions can respond to volatile market movements that can occur in minutes or hours.

One of the most compelling examples of technical risk that combines the vulnerabilities of smart contracts and mempools is Black Thursday on March 12, when the price of ETH plummeted along with BTC and other macro assets - “correlations go on the same Wednesday”, i.e. . another risk to guard against.

With ETH as MakerDAO's primary collateral, liquidations began to rapidly cascade as collateral ratios fell below the required liquidation thresholds. Oracle's pricing went awry, with some liquidation bots buying up around $8 million worth of ETH in zero-bid auctions, a behavior that BlockNative's forensic evidence shows was intentionally stacked by hammer bots during a time of excessive market volatility.

Ultimately, Maker stabilized as the platform's native governance token MKR was sold to stabilize the system's debt. However, short windows of opportunity are ripe for exploitation during market turmoil, as shown by BlockNative's analysis, which shows that liquidated collateral sells well below market value in just a few minutes.

March 12 demonstrates the multifaceted complexity of the risks DeFi faces. To counter such sophisticated vectors of insolvency or massive losses on the part of savers, more comprehensive risk management options are needed. In the case of Maker, the events of March 12 even required a trial.

Such threats do not even take into account first-level attack vectors such as 51% attacks. On-chain threats also include hard forks, which are a mixture of social and economic disagreements over the technical parameters of a protocol that can greatly reduce the value of a single chain. As a result of the token split (such as a hard fork of Bitcoin and Bitcoin Cash), there are interesting questions about how to mitigate the risk of token holders, especially as Ethereum ramps up its ETH 2.0 parallel chain in the coming weeks.

Level 1 vulnerabilities will only grow as more value moves onto the chain and Ethereum transitions to ETH 2.0.

Unfortunately, technical risk is not the only kind of danger that DeFi users should be aware of. With a composite, interdependent system of open protocols for exchanging value, the alignment of economic incentives creates additional complexity for correctly assessing risk.

How do you account for governance token price volatility or the relative liquidity of asset collateral in lending protocols based on user behavior? In a market where governance tokens from one protocol are used as collateral to grow the yield of another protocol and then staked on DEX to pay for trading fees purchased in LP tokens, it is difficult to justify the economic risks.

Luckily, Gauntlet Network and DeFi Pulse have recently teamed up to provide excellent metrics for assessing the risk profile of several major DeFi platforms. In particular, they take into account associated risk, user behavior, and the risk of smart contract/protocol parameters, which is a necessary step towards a more comprehensive risk analysis.

In DeFi, users have the unique freedom to choose from a buffet of liquidity pools, harvest opportunities, borrowing/lending protocols, and other platforms – in some cases, customizing their collateral ratio. Significantly more responsibility for risk assessment rests with those involved in the ecosystem, as risk mediation by third parties is greatly reduced.

Since user behavior influences risk much more than in traditional finance, the design of economic incentives is central to minimizing risk to users.

Complex agent-based risk models subsequently become necessary as users need to offload and automate some of the more complex market risk assessments.

The implications of economic risk analysis are also not always confusing. Economic risk assessment raises some important questions about the impact of user-selected collateral risk on capital efficiency and corporate governance, with the latter focusing on parametrizing risk through online voting.

Clearly, reasoning about the complex mix of technical and economic risks that DeFi faces is a difficult task. The type of risk faced by an automated series of smart contracts brokering a flood of billions without permission is unprecedented. However, the challenge of risk management in DeFi and the wider crypto market is also an emerging opportunity.

Never before has there been a place to develop complex derivatives, insurance and other financial instruments. The open nature of protocols, which leads to exploits like YAM and bZx, is being overshadowed by the potential flood of financial innovation just around the corner.

As long as Ethereum remains a permissionless open network, along with the increase in TVL in DeFi protocols, the likelihood of exposure to risk from the use of decentralized applications and smart contracts for the DeFi community will continue to grow. The main culprit for this vulnerability, linkability, is a double-edged sword between innovation and threats. As DeFi actors move and assemble features across established and new protocols, there is an equally strong need to navigate a potentially dangerous, misguided, and volatile space.

Many of the accidental or deliberate adaptations to the ever-emerging threats in Ethereum end up greatly improving other areas of DeFi. Others, such as the recent Harvest Finance exploit, expand on many questions about the correct identification and classification of exploits and the effective use of appropriate and mitigating asset protections that should arise.

For example, a debate that may sound like semantics is actually trying to pinpoint the purpose of a protocol. Should a protocol be proposed with no assumptions about the use of open, untrusted code, or should the community be able to reach a general consensus on conventions and usage that enforce the notion of acceptable and possibly safe usage?

Harvest Finance's ploy is typical of DeFi's risk dilemma. How do you quantify the unpredictable risk of complex arbitrage games using instant loans? Is this something that should be covered by security products or sophisticated risk management tools? If so, who assumes these risks, and if they are, how can these risks be assessed?

These are important questions with tangible economic implications that the wider DeFi community needs to address. Ingenious exploits that combine financial acumen with technical knowledge of composite protocols will continue. Now we need to determine where and how to mitigate their negative effects.

New types of risk require new types of protection. In the composable DeFi stack, not every risk is a bug, not all exploits are well-defined, and new types of risks are constantly emerging. Never before have financial entities been able to cash in on such a large amount almost instantly to take advantage of the opportunities on the network without permissions.

Instant credit attacks are likely to become commonplace in the composable DeFi ecosystem. Over time, new threats, even more sophisticated ones, may emerge. These are new dangers that blur the line between a brilliant power user's catch and an overtly malicious crime.

Back to the Harvest Finance exploit, could existing protection providers cover it? Let's study.

Many existing risk management tools (such as price risk hedging based on derivatives) and defensive products only partially address the fundamental risks of DeFi. For example, providing discretionary coverage only for smart contract exploits, not including economic risks such as complex arbitrage by the Harvest exploiter.

Specifically, Nexus Mutual smart contract coverage does not include:

“…Any events where inputs external to the smart contract system behave unintentionally and the smart contract system continues to operate as intended, where the inputs include but are not limited to: oracles, control systems, incentive structures , Miner Behavior and Network Congestion".

In addition, Nexus coverage does not cover a protocol associated with a protocol for which a protection pool is available. So, in the case of Harvest, if Harvest coverage had been available, the exploit would not have been covered, because the exploit involved manipulation of Curve Y Pool, and not explicitly Harvest's own contracts.

Therefore, Nexus Mutual, if it provided coverage for Harvest Finance, would probably have to initiate a community vote due to the fuzziness of the financial engineering deployed. However, the cards are more likely to be stacked against the plaintiffs as the language of the coverage explicitly excludes malicious economic engineering on the part of the user as a covered event.

Regardless of which side of the argument, the market demand for coverage of such events is inevitable and, more importantly, necessary for the mass adoption of DeFi.

The growing demand for granular risk management products is also generating compelling side effects, many of which benefit DeFi. For example, capital inefficiencies in over-collateralized (OC) lending in mainstream protocols such as Compound are driving creativity in the development of risk management products that have a meaningful result of improving capital efficiency throughout the DeFi ecosystem.

Well-designed protection contracts, for example with any excess of the amount of collateral required against fixed amounts of coverage, can significantly reduce over-collateral ratios for depositors. Functioning similarly to an American underlying collateral put option, the put option will cover the difference between the original collateral ratio (eg 150 percent) and the corresponding reduced ratio with the protection contract.

Lowering collateral requirements frees up capital that can then be used for low-risk crop growing opportunities, benefiting users, securing capital pools, and boosting returns in DeFi markets.

Risk management issues also permeate governance, making it a complex and fluid topic independent of the protocols it is used to address.

For example, emergency loans can be used to force executive voting, raising fears of future events that will negatively impact stakeholders without their consent, while still being subject to the rules of protocol. Moreover, community-driven DAOs are gradually taking on the risk management burden associated with community treasuries, marking them as green pastures for innovative fee/incentive restructuring and decisions on how to allocate stakeholder capital.

How do you ensure that corporate governance risks are covered? What will corporate governance risks look like in the future? Are key stakeholder capital allocation decisions worthy of their own risk management products?

At UNION, we analyze these issues beyond technical aspects and semantics by working on products that offer users a suite of protection products with varying levels of risk and reward for both buyers and protectors.

The only way to adequately counter sophisticated attack vectors is through comprehensive asset protection, which includes technical, economic, and user risk assessment. The idea is to provide different coverage options depending on the risk level of the user. Moreover, such coverage needs to be built from the ground up, without barriers to access and protecting users' assets in ways that have prevailed in CeFi.

If UNION were writing smart contract protection for Harvest Finance, how would the risk be covered if it does not fit within predetermined boundaries? No bug, no stolen keys - just loss of tolerance and smart financial engineering. How discretionary should be coverage of events such as instant loan arbitrage? Should "full protection" be offered?

Theoretically, this can be done by working with a quality auditor to assess the risk of smart contracts beyond logical or technical errors. Agent-based simulations can lead to stress testing in various scenarios to provide a better simulation of whether a successful (and oversized) term loan can be issued. The risk score can be passed to the UNION protocol, which converts the score into a protection premium and a capital requirement. The community could then determine through the UNION governance process whether to maintain coverage and any market incentives to attract liquidity providers.

If there is a need for more coverage, then UNION exists to ensure its development - whether that demand comes from crop degeneration traders and risk averse farmers or organizations hedging their positions.

An important offshoot of this risk assessment model is the inclusion of feedback, data, and disclosures about third party exploits. For example, how will Peter Zeitz (0x)'s disclosure of a vulnerability in Curve's smart contract amplification factor affect the reach of assets affected by the exploit, which once again blurs the line between technical and economic aspects for Curve users? In addition, can we extend these security models and products to help organizations manage their growing portfolios of digital assets?

At UNION, we believe full stack protection, lack of KYC, and liquid secondary markets can facilitate the emergence of more sophisticated protection tools to address complex exploit issues that arise from DeFi linking. Instead of being stuck on one side of the ideological spectrum, UNION provides DeFi users with a choice of which asset protection ideology to subscribe to.

UNION's modular structure allows you to tailor security solutions to specific threats.

Imagine a range of products with structured risks that support claims of exploitation. For example, security developers (i.e. LP for protection pools) for complex situations like Harvest earn higher revenues through pooled protection for various types of exploits - both economic and technical. Or protection pools with lower returns that only cover logical errors in the smart contract code and do not take into account agent-based risk assessment of economic threats.

The potential design space is limitless for products that fully meet market requirements.

To adequately address the evolving and complex risks DeFi faces, an open framework is needed for the development of complex risk assessment and coverage products.

That's where UNION comes in.

The UNION platform is designed as a crucible for scalable security products that can be combined to cover the technology stack and multiple economic risks that DeFi platforms face. High transaction costs, inefficient use of capital, partial protection coverage, and a lack of sophisticated protection products are holding back DeFi's pursuit of its ultimate goal of an alternative financial system.

By building a series of modules for capital pools, dynamic pricing and governance to manage cover risk and generate income for protection cover, UNION provides a scalable protection and risk management infrastructure that supports DeFi as a new and promising financial sector. Risk hedging in DeFi is more than just offering single protocol NFT contracts for discretionary smart contract vulnerabilities. It should include the mixture of evolving threats that Ethereum faces, which can be combined into more complex products.

Current asset protection platforms such as Nexus Mutual and NSure offer discretionary smart contract coverage but do not offer liquid secondary markets, comprehensive protection, or tranched structured risk products such as BarnBridge smart bonds.

UNION combines the benefits of current asset protection platform offerings while expanding their reach to include no-KYC, a modular toolkit for building complex products (like CDOs), and liquid secondary markets. Compared to the current market, UNION offers a much more open and accessible design space for all types of DeFi users, whether they are risk-averse or conservative when it comes to asset management.

By combining protection including vulnerability, gas fee, smart contract and even first level risk, UNION can achieve 3 significant advantages over competing protection models:

1. secondary markets;

2. Decentralized protection without KYC;

3. Reduced collateral requirements and optimal coverage price.

For example, aftermarket coverage is a natural advantage over Nexus Mutual's primary market coverage. Secondary markets not only increase liquidity, but also allow for the development of more sophisticated protection products that are commonplace within traditional finance. These products include credit default swaps (CDS) that can be used to model the protection premium against first-level vulnerabilities or the DeFi protocol.

Subsequently, we can present models for collateralized debt obligations (CDOs) in the form of CDS portfolios.

UNION CDOs may represent correlated smart contract risk across a portfolio of DeFi borrowing/lending protocols such as Aave, Compound, and Maker. Tranched risk products may even represent varying degrees of risk profiles in the price of ETH, which serves as collateral for various DeFi platforms.

This is just an introductory course for our next article, in which we will explore in detail the current DeFi asset protection platform market, characterizing different sides of the asset protection spectrum and classifying them into protection segments. We then compare UNION to the existing market, describing how the platform can bring together the fragmented aspects of the market into a comprehensive ecosystem with low barriers for advanced risk management.

DeFi participants are looking for smart tools to quantify and simplify risk management, from smart contracts to the network level and even the mempool. In a market where an individual's decision carries more risk than in a traditional financial market crowded with intermediaries, this is a compelling proposition.

It is impossible to predict the future vulnerabilities and risks of DeFi, mainly due to the composition of DeFi and the resulting super-fluid provisioning of open financial protocols. The development of platforms that cover the explicit demand for certain types of risk management (for example, discretionary coverage of smart contracts) can attract significant capital and users. But the ideal way to deliver end-to-end security products widely used in the future is to build a technology stack that supports the security needs of retail users, professional traders or institutions.

If DeFi protocols can be composable, then asset protection platforms must also be composable and inclusive.

Today's asset protection platforms fit into the vast design space for asset protection with a narrow focus. Available products are limited in scope based on specific user audiences. They do not take into account the composite risks that weave through the multiple layers of the Ethereum technology stack.

For example, given the paucity of available data and the volume of potentially unknown smart contract vulnerabilities, explicit description of bugs in the code is not enough to cover smart contracts. Instead, if coverage is modeled after CDS, it can extend to non-linear, unpredictable losses due to the smart contract layer, not just whether a bug was exploited. Such a tool offers coverage for situations such as economic exploits using term loans, oracle manipulation, and any other unforeseen events.

UNION combines an excellent governance model, end-to-end end-to-end protection, secondary markets, and an open (KYC-free) ecosystem to serve as the foundation for asset protection in Ethereum. Developers, traders, and organizations can then evolve from UNION, building and releasing tools based on what the market needs rather than what the design teams think the market needs.

Below, we briefly describe some of UNION's key design features and design features, and how they greatly advance the asset protection needle in DeFi.

An open, DAO-managed, KYC-free platform for creating and developing complex, multi-level risk derivatives based on market demand. UNION can offer disparate, stand-alone protection tools or pooled asset protection options covering the many layers and risks of DeFi, from the first tier to the mempool to the technical and economic risks of smart contracts. UNION is an open, inclusive platform that provides modular tools and encourages creative financial engineering based on organic market demand.

The platform includes the following features:

-Combined protection with different levels of coverage and separate protection from the impact of the writer.

-Decentralized, without KYC to lower the access barrier for users.

-Secondary markets to manage and trade risk for both buyers and advocates. More like the Lloyd of London model than the Nexus closed primary market, limited by KYC and internal bonding curve.

-A multi-token governance model that decouples governance from the market dynamics of buying and securing.

UNION is the basis for creating diverse products with different risk profiles for a dynamic ecosystem of users with specific requirements and needs. The platform does not depend solely on the broadcast derivatives model, the capital pool model, or derivatives-based price hedging. All of them can be combined into a single ecosystem with different pools, coverage and tools.

KYC/AML - No - low entry barrier.

Asset Protection Offering - pooled coverage pools covering all levels of the DeFi stack (e.g. tier one, smart contract, transactional gas), secondary markets for reinsurance and incentivizing the development of complex asset protection derivatives.

Management - a system of three tokens:

-The UNN is used for governance - voting on protection claims, appropriate conflict resolution protocols, adjusting risk parameters, and adjusting incentive programs.

-The uUNN is issued to protection buyers representing their rights to the protection policy (can be traded on secondary markets).

-pUNN is provided to protection pool liquidity providers and is a percentage of the pool they maintain (can be traded on secondary markets).

The three-part token model prevents conflicts of interest like what happened with Nexus Mutual with yInsure and SAFE tokens by separating governance from security/policy tokens.

Two levels of control using UNN:

-Community stakeholders;

-UNION DAO.

Community Stakeholders - Participate in governance processes such as evaluating requirements and proposing new treaties/protection instruments in exchange for economic incentives. Can even delegate control rights to others.

UNION DAO - An arbiter for polarizing community stakeholder decisions and a fail-safe for reversing decisions that harm the UNION ecosystem.

Robust three-tier requirements assessment model, where each pool acts as its own decentralized community (tier one), which can be expanded to members of all pools (tier two), and finally expanded to UNION DAO (tier three), which consists of professional judges with a significant stake in the UNION ecosystem.

Advantages

-Comprehensive protection includes the multi-layered risk of DeFi applications running on unauthorized blockchains. Shares the risk exposure of the defense writer while providing coverage from the bottom to the top of the DeFi stack.

-Robust capital and supply and demand based pricing model built on TradFi's time-tested asset protection.

-The initial suite of products includes (but is not limited to) transactional gas coverage, an overcollateralized product, and smart contract coverage – all of which are in line with the market in DeFi right now. Once released, they will have organic demand.

-Liquid secondary markets for risk sharing between protection writing protocols (eg reinsurance). Benefits also include reduced solvency margins, arbitrage opportunities in case of underestimated security risk, and access to experience from other security protocols.

Inclusive platform without KYC.

A governance framework that separates governance decisions from contracts and security tokens. Allows you to create on-demand protection pools and issue complex derivatives (such as CDS, CDO, etc.) to meet a variety of market needs.

Persistent exploits of DeFi protocols will continue. Preventive measures turned out to be completely insufficient for the financial engineering of malefactors. The DeFi attack surface will only increase as Ethereum’s composability and problematic interdependencies increase. The market must quickly shift its focus to robust asset protection, insurance, and risk management tools or face a similar form of growth bottleneck that Ethereum's scalability has created over the past few years.

Only until robust asset protection and mature insurance modeling flourish in Ethereum can DeFi reach its full potential. Until then, DeFi users should familiarize themselves with the options available and understand the risks of growing crops or providing liquidity to various pools without a guarantee that the funds carry SAFU in the event of the next imminent hack.