Diffusion Labs

Introduction

Diffusion Labs is developing Valent, a next-generation, peer-to-peer lending protocol that reimagines traditional pool-based lending by emphasizing immutability, governance-free operation, determinism, and self-sufficiency.

Designed to support multi-chain, long-tail assets with fixed rates and dynamic terms, Valent seeks to eliminate dependencies on external systems such as oracles while mitigating the vulnerabilities that have previously led to security breaches and economic exploitation.

Our engagement with Diffusion Labs involved a comprehensive mechanism audit and economic analysis aimed at evaluating the core functionality and design principles of Valent. This work is focused on identifying opportunities for optimization and ensuring that the protocol’s mechanisms are robust and well-aligned with market needs, without drawing any specific conclusions at this stage.

Scope

• Mechanism Audit: Perform an in-depth review of Valent’s core mechanisms—including on-chain bond creation, fixed rate lending, dynamic term management, and the bid matching engine—to assess their functionality and adherence to the defined design principles.
• Risk Management Evaluation: Analyze the protocol’s risk management frameworks to ensure they effectively minimize vulnerabilities and safeguard against economic exploitation, particularly in handling long-tail and multi-chain assets.
• Product-Market Fit Analysis: Evaluate various mechanism design options and approaches to determine the trade-offs, costs, and benefits inherent in the current architecture, with a focus on ensuring a sustainable and competitive market fit.
• Optimization Opportunities: Identify areas for improvement in key areas such as collateralization, fee structures, bid matching, and early repayment features, providing actionable insights to guide future protocol enhancements.
• Strategic Recommendations: Develop a set of strategic recommendations for mechanism design enhancements aimed at increasing overall protocol efficiency, capital utilization, and user trust, while maintaining a focus on self-sufficiency and determinism.

Results and Findings

The mechanism audit revealed several avenues for enhancing Valent’s design, particularly in terms of risk management and protocol determinism. Our findings underscore the importance of refining on-chain bond creation and fixed-rate lending mechanisms to ensure robust, peer-to-peer operations that can withstand multi-chain and long-tail asset challenges.