The events of the past few weeks have made it clear that many players in the DeFi ecosystem misunderstand who is responsible for risk when they deploy capital onto protocols. Furthermore, LPs lack an understanding of the core components of risk when deploying in protocols and vaults, i.e., asset selection, Protocol Selection, and curators versus strategy managers. The purpose of this article is to clearly define the source of risk, roles, and responsibilities, thereby informing LPs more effectively and making the ecosystem as a whole safer.

Understanding Different Levels of Risk

1. Asset level risk

We classify the risks inherent in individual tokens into clear, actionable categories.

Volatile assets

Definition: Assets whose prices fluctuate with supply and demand.
Examples: BTC, ETH.

Wrapped volatile assets

Definition: Tokenized wrappers of volatile assets (often on non-native chains).
Examples: wBTC, wETH.
Key considerations:

• Liquidity is typically deepest on the asset’s native chain; away from it, depth and routing can be limited.

• While the underlying may be robust, leveraged use of wrapped assets on non-native chains can incur losses if liquidity thins.

• Custody and bridge providers introduce additional operational and counterparty risk not present with native assets.

Liquid Staking / Restaked Tokens (LSTs / LRTs)

Definition: Derivatives that represent staked or re-staked positions in an underlying volatile asset.
Examples: stETH, LBTC.
Key considerations:

• These assets take on additional risk in exchange for additional utility.

• Users take on infrastructure risks related to restaking mechanics such as validator performance and slashing.

• Liquidity is often shallower than the underlying, increasing slippage and unwind risk.

Stablecoins — backed by U.S. Treasuries (regulated)

Definition: Tokens backed by cash equivalents and short-dated Treasuries with regulatory oversight.
Examples: USDC, PYUSD, RLUSD.
Key considerations:

• Generally subject to MTL/NYDFS/MiCA-style regimes (jurisdiction dependent).

• Attestations/audits and 1:1 reserve mandates improve transparency and solvency confidence.

Stablecoins — backed by U.S. Treasuries (unregulated)

Definition: Like regulated stablecoins, these are backed by cash equivalents and short-dated treasuries, but are less transparent and are do not meet regulatory requirements.

Example: USDT.
Key considerations:

• USDT is moving toward greater transparency but not aligned with the same disclosures/oversight as fully regulated peers.

Synthetic money — verifiable off-/on-chain structures

Definition: Backed by visible strategies (e.g., basis trades, over-collateralized lending) with some proof or reporting.
Examples: Ethena, Maple.
Key considerations:

• Not risk-free: solvency or even continuing operation of these assets could be threatened by sharp price declines with thin liquidity, auto-deleveraging (ADL) that breaks delta-neutrality, or counterparty failures.

Synthetic money — opaque structures

Definition: Backed by off-chain strategies with limited disclosure or non-public managers.
Examples: Elixir, Stream, Usual.
Key considerations:

• Opaque valuation methods (e.g., weak treatment of time value of money).

• Limited transparency and unclear accountability from founding teams increase model and governance risk.

2. Protocols - Focused on Money Markets

The fundamental difference is about who is responsible for asset selection and risk validation.

Centralized risk management

Definition: Risk is managed by centralized parties for the benefit of the protocol as a whole

Examples: Aave, Kamino.
Characteristics:

• Protocol assumes responsibility for the opportunities presented on its platform by hiring a risk manager to support the protocol

• Protocol-appointed risk managers (e.g., Chaos Labs, Llama Risk) set parameters such as IRM and LTV and vet listed assets.

• Protocols may offer cover option like Aave’s Safety Module.

• LPs rely on the protocol’s due diligence; they do not need to independently rank, say, USDC vs. Usual.

Decentralized risk management

Definition: The protocol creates a platform for any entity to create a vault

Examples: Morpho, Euler.
Characteristics:

• Open platforms where any curator can launch a vault.

• No protocol-level endorsement of curator credibility; the platform markets infrastructure, not specific vaults.

• Asset quality is not validated by the protocol; risk passes to LPs at a granular level.

Vault curators

Entities that configure vaults on a single protocol by choosing a combination of assets and risk metrics, such as the IRM (interest rate model) and the LTVs of collateral assets on a single protocol. They typically provide limited active management and do not assume liability for asset quality.

Examples: Gauntlet, Steakhouse, RE7, MEV Capital.

There have been numerous examples of users losing funds in decentralized risk-managed protocols.

• The root cause for most of the losses in these vaults is poor asset selection

• Curators frequently optimize for TVL and Yield but take no responsibility for the safety of user funds. Any losses are the sole responsibility of the LPs who deploy into these vaults that use these curators

3. Common Misconception: Vault Curators ≠ Strategy Managers

Vault curators operate inside a single-protocol framework and optimize parameters; they often do not underwrite asset safety.

Strategy managers, by contrast, design multi-protocol, yield-generating strategies and own the end-to-end risk process: asset validation, collateral selection, parameter setting, execution, and monitoring. They target higher risk-adjusted yields through structural design, not by reaching for riskier assets.

What good strategy management entails:

• Proactive and automated risk management with real-time monitoring and rules-based rebalancing, even during off-hours market shocks.

• Predefined unwind paths (bridges, venues, depth checks) and stress-tested slippage/latency tolerances.

• A first principle of return of capital over return on capital.

Who should choose strategy managers?

LPs who cannot (or prefer not to) perform deep asset and protocol risk analysis benefit most from accountable, multi-protocol strategy managers with transparent risk policies and proven execution.

Setting the Record Straight

With the emergence of vault protocols such as Morpho, there is widespread misunderstanding of the risk that an LP takes when deploying.  While Morpho and Euler have been very clear in explaining the points outlined above, it seems that many LPs misunderstand the user manual, which leads to frustrations when events such as those of the past week occur.

When deploying funds as an LP, it's your responsibility to understand the assets, protocols, and risk managers you are exposing your funds to. In our view, Morpho/Euler passes down the responsibility for understanding risk at a more granular level to the LPs. By contrast, Aave centralizes more of that responsibility by engaging external risk managers and offering protocol-level cover options (e.g., the Safety Module).  

None of this makes Aave “risk-free.” Aave can be more suitable for users who are less risk-savvy or unable to actively manage the risks that decentralized models pass through, but losses can still occur—from excessive leverage, slippage in thin markets, bad debt, or liquidations. The point is simple: centralized vs. decentralized risk management are different trade-offs, and LPs should evaluate them deliberately before allocating.

The Path Forward: From Asset Selection to Risk Discipline

If DeFi is to mature, it must move from blind aggregation to informed selection. Every new market or vault should start with one question: What, precisely, backs this token?

Professional risk management starts there. It maps collateral types, quantifies liquidity depth, and defines escalation procedures for when assumptions fail. That philosophy — turning transparency into measurable discipline — is what institutions expect and what users deserve.

In the upcoming companion piece to this article, “How Sentora Manages Risk in DeFi,” we outline how Sentora’s six-bucket framework and continuous monitoring process bring that discipline to life — transforming asset analysis into live, auditable risk management.

 - ADM, CEO Sentora