Operationalizing your Risk Management Program with a Control Environment

Part 3 of a series focused on implementing a robust risk management program for your DeFi activities

Welcome to the final installment of our blog series on how to build a DeFi risk management program based upon leveraging a prioritized risk framework, to implement operational rules and control activities. In Part 1, we introduced our comprehensive Risk Framework, and in Part 2, we detailed how our assessment methodology provides a method to prioritize risks to focus your risk management program’s efforts. In this concluding part, we will explore how Ledger Works operationalizes your risk management program by implementing controls to address your prioritized risks.

Transforming Risk Priorities into Action

At Ledger Works, we believe that effective risk management goes beyond identifying and prioritizing risks. It requires translating these insights into actionable operational processes that enhance security, optimize performance, and ensure regulatory compliance. Our operating model for deploying an enterprise risk management program includes not only identifying key prioritized risks but also deploying operational controls to detect, prevent, transfer, and correct risks in the operating environment. Before operationalizing a risk management program, it is key to understand control objectives and activities.

Control Objectives and Activities

Control objectives and control activities are fundamental components of an organization’s internal control framework. They work together to ensure the effectiveness, efficiency, and compliance of operations. Here’s a detailed explanation:

Control Objectives

Control objectives are the specific goals that an organization aims to achieve through its risk management program. They help guide the design and implementation of control activities. Common control objectives include:

1. Operational Efficiency: Aims to enhance the efficiency and effectiveness of operations, minimizing waste and optimizing resources.
2. Compliance with Laws and Regulations: Ensures adherence to applicable laws, regulations, and organizational policies, reducing the risk of legal penalties.
3. Safeguarding of Assets: Protects organizational assets from theft, loss, or misuse, ensuring their proper use and preservation.

Control Activities

Control activities are the specific actions and procedures that help achieve control objectives. They can be categorized into several types, including:

1. Preventive Controls: Designed to prevent errors or irregularities from occurring in the first place. Examples include segregation of duties, authorization processes, and employee training.
2. Detective Controls: Aim to identify and detect errors or irregularities that have already occurred. Examples include reconciliations, audits, and variance analyses.
3. Corrective Controls: Focus on correcting identified issues to restore operations and prevent recurrence. Examples include process improvements and disciplinary measures for policy violations.

Integration of Objectives and Activities

Control objectives provide a framework for what the organization wants to achieve, while control activities are the means to achieve those objectives. By aligning control activities with specific control objectives, organizations can create a robust internal control environment that supports overall business goals. In summary, control objectives set the direction for what needs to be accomplished, while control activities are the actionable steps taken to meet those objectives, ensuring effective governance and risk management.

Continuous Controls Monitoring

Continuous Controls Monitoring (CCM) is an ongoing process that helps organizations ensure their internal controls are functioning effectively and efficiently. It involves the use of technology and analytical techniques to monitor key controls in real-time or near-real-time. Here’s an overview of its key components:

1. Real-Time Monitoring: Uses automated systems to continuously track transactions and activities, allowing for immediate detection of anomalies or compliance issues. Enables quick responses to potential risks before they escalate.
2. Data Analytics: Employs data analysis tools to evaluate large volumes of data for patterns, trends, and irregularities. Helps identify areas where controls may be failing or where risks are increasing.
3. Integration with Business Processes: Integrates monitoring with day-to-day business operations, ensuring that controls are embedded within processes rather than being separate or periodic. Facilitates a seamless approach to risk management.
4. Key Performance Indicators (KPIs): Establishes KPIs related to control effectiveness, compliance rates, and risk exposure. Regularly assesses performance against these indicators to determine if controls are working as intended.
5. Alerting Mechanisms: Sets up alerts to notify relevant personnel of unusual activities or control failures. Enables prompt investigation and remediation.
6. Documentation and Reporting: Maintains records of monitoring activities, findings, and corrective actions taken. Provides transparency and supports audits and compliance reviews.
7. Continuous Improvement: Regularly reviews and updates monitoring processes based on findings and changes in the business environment. Encourages a culture of proactive risk management and control enhancement.

By implementing continuous controls monitoring, organizations can enhance their ability to detect and respond to risks, improve compliance with regulations, and maintain the overall integrity of their operations. This proactive approach not only protects assets but also supports informed decision-making.

RiskOps-as-a-Service: Operationalizing Controls to Protect & Optimize Your Environment

Ledger Works’ model for operationalizing a risk management program, identified below, leverages a continuous monitoring environment to implement controls to address prioritized risks.

Figure 1: Risk Management Architecture outlining dark blue outer circles illustrating identified and prioritized risks, with an inner circle establishing a data infrastructure to collect, enrich, and analyze data to transform it into actionable intelligence that can trigger security, operations, and financial controls to protect and optimize DeFi financial performance

Ledger Works RiskOps-as-a-Service offering integrates several key components:

• Data Infrastructure: Establishing a continuous controls monitoring environment starts with establishing a comprehensive monitoring capability based on access to near real-time data at scale across all relevant operating environments. This includes data not just about a DeFi’s direct smart contract operations, but also data related to the counterparties and broader market conditions. This blockchain data must be ingested, transferred, and enriched from the initial, often unintelligible data, into actionable intelligence.
• Actionable Intelligence: From rich intelligence, trained machine learning models must be able to computationally act on this intelligence in near real-time and at scale. This means thousands of rules and ML-based controls must be able to act based on triggering events and patterns discovered.
• Direct Action: Identify an exploitation of a vulnerability, or the realization of an operational problem that requires direct action immediately to mitigate risk or optimize the performance of an automated on-chain environment. These actions may involve notifications or direct systematic actions.

Planning and implementation of control environments

While many risks may leverage standard controls, some may require specifically designed controls and even quantitative models to target an enhancement or protection opportunity. Qualified data scientists are often required to develop and test financial risk models to address new and distinct opportunities for revenue optimization and loss risk mitigation.

Ledger Works starts with a Risk Assessment (RA) and Control Framework (CF) based on our experience working with DeFi protocols. This framework establishes a foundation to implement risk management program controls. From this starting foundation, additional targeted controls may be tailored to address specific prioritized risks, ensuring that a DeFi protocol can establish a risk posture that makes sense for their business.

An example of risks to control objectives to control activities

Based on a prioritized risk framework, a set of target risks is established. Each of these risks is managed by establishing key control objectives, which, if achieved, would mitigate the risk. To achieve a control objective, control activities are established as the specific practices used to meet that objective. An example of control activities used to address a DeFi Protocol’s Smart Contract Risk includes the following, as illustrated below.

Figure 2: Mapping of Risks to Control Objective to Control Activity. Specifically noting Risk R4 — Protocol Smart Contract Risk, including Control Objective CO9 — Failure of smart contract to function as intended, which could be managed with a series of Control Activities including identifying write events or changes to the contract, or failed calls or unexpected/invalid transactions, etc.

Concluding thought: A note beyond Risks and Controls

A comprehensive risk management program goes beyond the periodic risk assessment and resulting risk and control framework, even when fully operationalized. There are a number of other elements that must be considered as part of an overall risk management program that are beyond the scope of this blog series. By way of example, business continuity and crisis management programs generally and an effective incident response program specifically are important parts of risk management and will be considered in a figure blog in greater depth.

Thank you for following our blog series. If you missed Part 1 or Part 2, you can read them [here] to complete your understanding of our approach to DeFi risk management. Stay tuned for future updates as we continue to innovate and support the DeFi community with cutting-edge solutions. As a final note, please reach out for a detailed risk assessment of your company’s on-chain activities and to explore how our solutions can enhance your risk management program. Contact us today.

About Ledger Works

Ledger Works helps our customers focus on growing their Web3 business while we run their Risk Operations. Today, more than ever, our customers’ success requires effective Risk Management. As their strategic risk partner, we help optimize financial performance while minimizing risk of loss. By leveraging real-time computational rules, continuous execution of deterministic and simulation models, and real-time market surveillance, Ledger Works empowers businesses to turn risk into a competitive advantage.

For more information, visit: https://www.lworks.io

Contact: Press@lworks.io

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Read our 3 part series on how to operationalize a world-class risk framework to protect, prioritize, and operationalize DeFi on-chain risk:
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Part 1: Protecting Your DeFi On-chain Operations with a World-Class Risk Management Program

Part 2: Prioritizing Your DeFi Risk Management Efforts

Part 3: Operationalizing Your Risk Management Program

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