Using Defrost protocols and/or the associated stablecoin H2O doesn't come without risk. Before you decide to deposit your assets in the protocol or acquire the stablecoin for leverages, you should do your research and understand the risks involved.
The core Defrost protocol contracts are being audited. However, security audits do not completely eliminate smart contract risk. We urge you not to put your life savings or money you can't afford to lose into Defrost protocols.
The H2O over-collateralization mechanism is reliant upon the timely and successful liquidation of the risky vaults, that fall out of the Minumum Collateral Ratio. However, the main risks are associated with specific collateral types backing these stablecoins. If the values of the underlying collateralized asset drop too quickly, liquidation might not be enough to cover the full amount that was borrowed.
At this particular time, the liquidators may be reluctant to exercise liquidation, as the liquidation rewards may not be enough to cover the potential risks, considering the increased gas costs and conjunctions. Or the public chains are too jammed to timely process the liquidation transactions.
These cases may lead to liquidation failure and can cause the collateral not enough to back the H2O coins in circulation.
If the H2O liquidity is not deep enough, and there are not enough arbitrageurs on the market. The dramatic change of supply or demand of H2O may lead to sharp price changes in a short period of time, which make H2O away from the 1:1 USD peg.
Stability Fee Rate and Savings Rate are monetary tools to adjust the supply and demand of H2O. However, if these tools are not adjusted timely or poor adjustments are made, H2O may further drift away from the peg. It may cause FUD to the Defrost Protocol and lead to the market run.
Defrost Protocols enable users to stake collaterals for minting H2O. The collaterals can be LP tokens or various pool tokens from other DeFi protocols. Due to the composable nature of Defrost protocols, they are built with smart contracts interacting with one another in some form. The operation relies upon the stability of the integrated DeFi Protocols and cross-chain mechanisms. Smart contract failure in one of the core components could cause a ripple effect throughout the Defrost Protocols.
This means that smart contract failure on the base layers could lead to loss of funds in the protocols or applications that are built at the higher layers, like Defrost Protocols.