Economic red flags

Economic red flags refer to potential weaknesses in a DeFi protocol’s economic or financial design, rather than its smart contract security. In simple terms, these are issues in the way money flows or incentives are structured, which could lead to financial losses even if the underlying code functions correctly.

Shift maintains a detailed checklist of these red flags, developed by analyzing historical failures in the DeFi market. This checklist helps Shift proactively identify economic risks for any asset or protocol it considers for investment.

If a project has an economic red flag, it signals a known vulnerability or flaw in the project's design, potentially leading to exploitation or breakdown. Shift uses these flags to either avoid risky investments or put extra safeguards, like trigger systems, in place to protect investors.

Many DeFi incidents aren't due to code exploits, but arise because of economic vulnerabilities—such as liquidity issues or market manipulations—that the original developers hadn't anticipated. That’s why Shift closely examines the economic stability and incentives of every protocol.

Overview of economic red flags

The following table outlines some common economic risks that Shift evaluates:

Vector	Red flag	Key question to assess risk	Max rating
Prior Exploits	This Protocol Economic Exploits	Has this protocol ever suffered an economic exploit?	A
Prior Exploits	This Protocol Technical Exploit	Has this protocol ever suffered a technical exploit?	A
Prior Exploits	Fork Protocols Economic Exploits	Have any forks of this protocol experienced economic exploits?	AAA
Prior Exploits	Fork Protocols Technical Exploits	Have any forks of this protocol experienced technical exploits?	AAA
DAO	Malicious DAO Decisions	Can any DAO decisions potentially lead to loss of funds?	AAA
DAO	DAO Democracy	Does any single entity control a majority of DAO votes?	A
DAO	DAO Decisions Implementation	Is there a time delay or buffer before DAO decisions take effect?	A
Lending	Unapproved Assets	Are all collateral assets included in the approved asset list?	BBB
Lending	Collateral Factor	Is the collateral factor for non-stable assets at least 0.825?	A
Lending	Borrow to Supply Ratio	Is the borrow-to-supply ratio below 60%?	AA
Lending	Market Liquidators	Are liquidations carried out by independent, third-party actors?	BB
Stablecoins	Algorithmic Model	If using stablecoins beyond USDC/USDT, is the peg maintained without algorithmic mechanisms?	A
Stablecoins	Collateral	Can the stablecoin withstand more than a 2% depeg from market volatility?	A
Stablecoins	Collateral Security	If using non-USDC/USDT stablecoins, is their collateral never reinvested?	BBB
Stablecoins	Redemption	Is redemption of non-USDC/USDT stablecoins always available?	BBB
Stablecoins	Centralisation	Is the stablecoin free from centralization risks?	BBB
Price Oracle Issue	Price Oracle	Is a trusted price oracle (like Chainlink) being used?	A
Price Oracle Issue	True price from price oracle	Are oracle prices based on live market data, not hardcoded values?	AA

Practical example: economic checks for Aave V3 Ethereum

When Shift evaluates Aave V3 Ethereum, a lending protocol, it carefully examines specific risk vectors:

DAO structure

Two main risks are flagged here:

• Malicious DAO decisions

• DAO democracy (concentration of voting power)

Both risks are addressed by implementing triggers that actively monitor all DAO proposals, reducing their impact.

Lending risks

Shift evaluates critical lending risks, including:

• Unapproved assets: A red flag here triggers automated liquidation monitoring during market volatility.

• Collateral factor: If the collateral factor is insufficient, another trigger monitors liquidation health.

• Borrow-to-supply ratio: Shift checks this ratio to ensure borrowing remains sustainable.

• Independent liquidators: The presence of multiple independent liquidators (verified via Dune Analytics) confirms the market's robustness.

Price oracle risks

Because accurate pricing is essential, Shift identifies any risks around oracles. Although Aave V3 Ethereum mostly relies on reliable Chainlink oracles, some prices are hardcoded—potentially increasing risk. Shift sets specific triggers to closely monitor these situations.

In summary, although several red flags are identified for Aave V3 Ethereum, each one is carefully managed by Shift's proactive trigger system. Thus, despite these flags, the economic risks are well controlled and do not negatively impact Aave’s overall risk rating.