ChaosLabs has proposed a new stress-testing framework for Aave V3, aiming to set the supply cap for each token and measure the potential accrual of bad debt in high-risk situations. The framework is designed to limit protocol losses to a target loss K, initially set at 0.1% of the safety module’s funds, or $400K USD. The stress scenarios are categorized as Moderate and Severe, and are differentiated between stablecoins and non-stablecoins. The framework also includes a sensitivity analysis on the price and liquidity trajectories, aiming to make Aave more resilient to any hypothetical stress event¹.

The framework considers FRAX and CRV as riskier assets, while USDC and LINK are deemed safer. Protocol losses are simulated using each token's respective stress scenario to determine supply caps. Tokens not used as collateral have negligible liquidity risk, but protocol losses are still simulated as if 25% of the token's supply is used as collateral to set sensible supply caps. For new asset listings, the supply and borrow distribution from a similar asset is used as a starting point for simulations. The methodology also takes into account LSDs, concentration risk mitigation, and price manipulation. The community has the option to raise the threshold if it limits future supply cap increases¹.

Llamaxyz raised a question about the 0.1% of the Safety Modules (SM) funds, suggesting that a nominal % of revenue or allocated $$ amount might be a more suitable definition due to the high volatility of the assets in the SM². In response, ChaosLabs clarified that they use a threshold of $400K as the initial target loss for their recommendations, chosen as an initial conservative figure. They use binary search for optimal supply caps, limiting protocol losses to some target loss K. If this target loss proves to be limiting in terms of increasing supply caps for certain assets over time, the community can decide to raise the threshold to reflect a higher risk appetite³.