---
tags: LitReview
---

# Delegation Overview



## Prior Research

- cadCAD model centered around price discovery and delegation in a "perfect" world
- Slashing was not a potential within the system
- Other general risks were not modeled

## Current Considerations

### Summary
- What are the ways in which risk can propagate through the system in regards to the delegation process and in what ways can the system reduce risk.
- Review of traditional finance risk reduction in regards to liquidity, counterparty risk and rehypothecation: [Leverage, Rehypothecation & Counterparty Risk: Lessons from Traditional Finance](https://hackmd.io/ABJRYVDlQ8iiz7O9VSIIDg)

### Delegator Risks
- Losing working capital due to slashing on the broker
- Dilution of claims to yield of brokers due to an influx of other delegator staking on the same broker
- Being penalized for requesting a return of funds when there aren't enough funds in reserve (causing the broker to early cancel on agreements)

### Broker Risks

- Demand for withdrawal when funds are low or insufficient
- Ineffecient allocation of delegator capital leading to low working capital

### Mechanism Considerations

- What defines the rights of different delegators? Does one have a larger claim in the case of a bankruptcy?
- Is there a way to reward early delegators more than the later delegators
- How can a "run on the bank" scenario for a broker be mitigated
- How can capital allocation be optimized so that:
- High performing brokers receive more stake
- There is not concentration in only a few brokers
- How can delegators have their risks associated with brokers being slashed reduced
- In what way is the delegated stake tracked? Is each delegator's stake tracked specifically to where the broker stakes on a stream or will a pool of funds be used?
- What about the edge case where a new delegator puts stake in and then immediately a prior delegator withdraws?
- Can a broker be forced to withdraw from streams they have staked on when a delegator asks for capital back?
- What is the best way to allocate the lost stake from slashing where the broker is fault
- What is the best way to allocate lost stake from slashing or lost earnings when a delegator asks to pull money out and there is not enough of a reserve.

## Traditional Finance Risk Reduction

- The following should serve as inspiration for possible mechanism design. It is taken directly from the review document.
- Central counterparty clearing houses (CCPs) deal with this issue of mutualizing risk across a large amount of stakeholders for bankruptcy.

### Loss Mutualisation

- By collecting premiums from particpants, CCPs negate the majority of credit risk participants have because when someone defaults, they pay out from the fund to replace the defaulter.
- Insurance companies run on the same premise.

### Margin

- An initial margin is required when getting into a position
- As losses accumulate, there are cutoffs where a margin call happens and the CCP will request a variation margin


### Borrow Rate

- In securities lending, there some stocks are very plentiful and others which are "hard to borrow"
- One reason a stock may be hard to borrow is because so many people are shorting the stock so must of the stock has been loaned out already
- Banks deal with "hard to borrow" stocks by charging a higher spread; it costs more in terms of yield to borrow stocks like these.
- Some extreme examples are stocks that are so shorted that the rate to borrow can be an annualized 10%.

### Spread

- When an executing broker is doing a principal trade, they price in the extra risk by increasing the spread.
- The higher the risk, the higher they increase the spread to cover possible losses

### Credit Checks/Scoring

- In an attempt to eliminate those most likely to default, banks use credit checks and credit score to quantify how likely someone is to default.
- Loan rates can also be adjusted to make up for extra risk different borrowers have.

### Letters of Credit

- The LTCM example showcased how in the short term, liquidity can be a huge issue.
- Letters of credit are bank pledges that in the case of a need for liquidity, they will provide it to a firm.
- These letters of credit can be useful to reduce risk for a firm. In the case where they are temporarily under water, having the ability to call on the letter of credit to get a capital injection can mitigate the risk of default.

### Lock-up Periods

- A common technique that hedge funds use is to mandate a lock-up period for withdrawing capital. This period of time is usually something like 3 months after an investor asks to withdraw money from the fund.
- The lock-up period allows the fund time to find good pricing on any assets they might need to sell in order to meet the redemption request.
- Allows for better liquidity management

## System Specification

- To analyze the system, the specification of the system is being written. It can be found here: [Delegation Smart Contract Specification
](https://hackmd.io/6fN8ITTeTVyMwV3ToeApSw)