Overview

This note details how Clearstar conducts Protocol Due Diligence on yield opportunities. It is a part of the Capital Allocation Framework and covers the assessment of the protocol layer: its design, economic model, operational history, and the soundness of its core mechanics.

This stage is human-led. Analysts conduct the research directly, with assistance from VALIS submodules where relevant (e.g. on-chain data retrieval, historical transaction analysis). The full VALIS pipeline does not run for Specific DD; it is reserved for General Due Diligence. Findings from VALIS's General DD report may, however, provide useful context and starting points for the analyst's work here.

Distinction from General DD General Due Diligence asks: "Is this protocol's code secure and its governance sound?" Protocol DD asks: "Does this protocol's design make sense, does the maths check out, and has this model been proven in practice?"

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Escalation If the analyst identifies a critical finding during Protocol DD that materially changes the risk profile (e.g. a fundamental flaw in the protocol's mathematical model, an unreported exploit, or a dependency chain failure), the analyst escalates immediately to the senior analyst. The senior analyst determines whether to pause all Specific DD tracks, request additional data, or flag the finding for Improvements & Engagement.

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flowchart TD
    A[Opportunity enters Protocol DD] --> B[Classify protocol category and lineage]
    B --> C[Analyst assesses 8 areas]
    C --> D[Each area graded A through F]
    D --> E{Any critical finding?}
    E -->|Yes| F[Escalate to senior analyst]
    E -->|No| G[Compile composite score]
    F --> H[Senior analyst determines action]
    G --> I[Protocol DD report produced]
    I --> J["Feeds into APB Risk Rating (P component)"]

    style A fill:#4A90D9,stroke:#2E6BA6,color:#fff
    style E fill:#E8A838,stroke:#B8862D,color:#fff
    style F fill:#D9534F,stroke:#A94442,color:#fff
    style I fill:#5BB85B,stroke:#3D8B3D,color:#fff
    style J fill:#5BB85B,stroke:#3D8B3D,color:#fff

Protocol Classification

The first step in Protocol DD is to classify the protocol by its category and lineage, as this determines which design patterns, risk factors, and benchmarks are most relevant.

Protocol Category	Description	Key Design Considerations
Lending	Protocols that facilitate borrowing and lending of assets (e.g. overcollateralised lending, undercollateralised lending)	Liquidation mechanics, interest rate models, collateral factor calibration, bad debt handling
DEX	Decentralised exchanges facilitating asset swaps (e.g. AMMs, order books)	Pool mechanics, impermanent loss exposure, fee structure, MEV protection
CDP	Collateralised debt position protocols that mint synthetic assets against collateral	Collateralisation ratios, liquidation thresholds, peg stability mechanisms, debt ceiling management
Liquid Staking	Protocols that issue liquid representations of staked assets	Validator selection, withdrawal mechanics, slashing pass-through, exchange rate accuracy
Yield Aggregator	Protocols that optimise yield across multiple underlying strategies	Strategy selection logic, rebalancing mechanics, fee layering, dependency chain depth
Derivatives	Protocols offering synthetic exposure, options, or perpetual contracts	Funding rate mechanics, margin requirements, oracle dependency, settlement mechanics
RWA	Protocols that tokenise real-world assets	Legal structure, asset custody, redemption enforceability, audit and attestation frequency

Forks and proven models If the protocol is a fork of an established protocol, the analyst documents the original protocol, the extent of the modifications, and whether the modifications introduce new risk. A protocol that is a minimal fork of a battle-tested design carries a different risk profile from one that has significantly altered the original mechanics. Forked code that has not been separately audited is flagged as a concern.

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Assessment Areas

Protocol Due Diligence covers eight areas. Each area receives a letter grade (A through F), consistent with the rating scale used in General Due Diligence.

1. Protocol Design and Mechanics

This is the core of Protocol DD. It examines whether the protocol's design is sound and whether the mechanics work as intended.

Key questions addressed: