# Notional's Performance During Extreme Volatility

In this post we’ll examine what risks Defi Lending Protocols Face, how Notional manages them, and how Notional’s risk mitigation measures performed in the recent market volatility.

Over the last few months, we witnessed large centralized crypto lenders halting withdrawals and even defaulting on some of their obligations due to wholly inadequate risk management. The recent events highlighted how DeFi protocols like Notional differ from their CeFi counterparts due to attributes like:

• Overcollateralization
• Transparency
• Organic yield generated on-chain
• Predictable and smart contract-enforced liquidations

These qualities have made DeFi lending protocols much safer than CeFi lending desks. But although major DeFi protocols have so far proven to be highly robust, they are still subject to real economic and technological challenges such as price risks, oracle risks and liquidity risks.

TL;DR

• Notional proved to be extremely resilient and was highly effective at protecting users in times of high volatility.
• Liquidations worked exactly as intended with multiple parties competing to liquidate risky accounts in a timely manner.

## Historical Performance of Notional

Let’s now look at how Notional handled the extreme volatility of crypto markets over the past few months.

As a reference, BTC and ETH respectively lost 48% and 63% of their value over the months of May and June 2022. Over that same time period, UST lost its peg and erased close to $60B of market value in the Terra ecosystem in the process. Large funds like 3AC went belly-up, and large, centralized crypto lenders suffered major liquidity problems. Notional on the other hand remained fully solvent, and Notional’s users were able to redeem their assets at any time without issue. Let’s dive into how the protocol handled redemptions and the liquidation of risky accounts in these crucial times. ### Redemptions nTokens remained fully redeemable at all times even as their TVL decreased by -78% in less than 2 months due to massive redemptions. As the markets tumbled, some LPs (nToken holders) withdrew their liquidity (redeemed their nTokens) from Notional in order to recollateralize their positions on other protocols or actively deploy their liquidity to other opportunities. As an example, on the day of UST’s implosion, multiple LPs redeemed their liquidity from Notional with 2 LPs redeeming$105M in 3 transactions which represented a 56% decrease in nToken TVL in less than 24 hours:

We also witnessed multiple nWBTC redemptions for a total of 75% of the outstanding nWBTC supply in late May. These redemptions pushed the WBTC yield curve to its lower bound of 0.3%. Some users subsequently benefited from these low rates to borrow WBTC. But again, users were always able to access their funds despite sky-high redemption rates.

### Liquidations

As crypto prices decreased over the months of May and June, 8 accounts became undercollateralized. As a consequence, $1.4M in collateral assets were liquidated across 20 liquidation transactions. All undercollateralized accounts were liquidated in a timely manner and the protocol experienced no insolvencies. The following graph displays the amounts of collateral assets that were liquidated over time. We can see that liquidations clustered around May 12th when UST depegged and in mid-June when crypto prices declined abruptly. These liquidations were conducted by 5 liquidators who generated a total of$66K in profits. The following graph displays how much each liquidator generated in profits:

### Breaking down liquidation profitability

To take this a step further, we can use historical analysis to determine whether liquidations would have been profitable at different times during the price crash and see how Notional would have performed if it had more risky debt on the protocol. In short, Notional would have been reliably able to liquidate large, risky borrowers at all times throughout the market volatility.

To perform this analysis, we need to first dig in to exactly how liquidations work. The typical ETH/USDC liquidation uses flash loans and is structured like this:

• Flash borrow USDC
• Purchase the risky account’s ETH in exchange for USDC at a discount to the current oracle price
• Swap the purchased ETH for USDC on a DEX like Uniswap
• Repay the flash loan and pocket the USDC difference

This liquidation structure implies that the following variables impact the PnL of liquidators:

Liquidator PnL = Liquidation discount - Price basis - Slippage - Fees - Gas costs

The price basis corresponds to the price difference between Notional’s Chainlink oracle price and DEX market prices.

### Liquidation profitability

It is critical that the liquidation discount offered to liquidators is sufficient to cover for liquidation-related costs during stressed market conditions. If liquidations are profitable, we can be confident that they will happen. To determine if liquidations would have happened, beyond the liquidations that did happen, we can simulate the profitability of liquidating $10K and$1M in ETH collateral on May 12th during UST’s depeg event.

In order to simulate a liquidator’s expected profitability over time, we started with the 6% liquidation discount the protocol gives to liquidators. We then factored in the historical price basis between Notional’s oracle prices and market prices into the liquidation PnL. We then computed the relative gas cost of liquidating an account on a block per block basis using historical data. Finally, we included the trading costs (ex: swap fees, slippage) of liquidating an account to our calculation.

This analysis demonstrates that Notional’s liquidations would have been reliably profitable even through extreme market turbulence. As we can see, the net profitability of liquidating $1M in ETH usually hovers around 5%, resulting in a profit of$50K.We can also see that the liquidation profitability has been overwhelmingly positive for $1M liquidations across this 24 hour period, with very brief moments of slightly negative profitability. The longest time period where the profitability of liquidating$1M of ETH was negative spanned less than 8 minutes and was mainly due to a large price basis between the market price and the Chainlink oracle price.