Passive OVL holders effectively act as the counterparty to all unbalanced trades in the system (# longs != # shorts).
If the system prints substantially more than expected, holders face risk of significant dilution. This includes, in particular, spot OVL-ETH liquidity providers that backstop liquidity for users to enter and exit the system. If they pull their liquidity due to excessive dilution with not enough rewards from market trading fees (+ also liquidity mining initially), it means users can't get into or out of the system to trade.
We'll be implementing caps on the total open interest on long and short sides as well as a funding rate to encourage balance and draw down this risk over time, but it still remains substantial if our risk management approaches fail.
If a user is able to manipulate the oracle feed for any market we choose to offer, they could take out a max leverage long or short position on the system, then proceed to manipulate the oracle value to their advantage.
If the cost to manipulate the oracle value plus the cost to enter into the max leverage long or short on the market is less than the value of the market position after manipulation, the attack will be profitable and the attacker would print "free" OVL.
With TWAP markets (what we'll use at launch), the cost of this attack is on the order of $240M+ for a spot pool with liquidity of $20M+ with max leverage of 5x. We need to choose our markets and the feeds that we wish to offer in the future based off of our ability to calculate what the cost of this attack will be, so it is substantial.
The OVL-ETH TWAP as a market to trade on Overlay should be available if there's enough liquidity in the spot pool. The benefit of this is:
The downside to offering OVL-ETH as a market on Overlay is the risk of an OVL price death spiral. If there is a complete loss of faith in OVL and the price collapses while users on the Overlay market are overall bearish OVL price, these users could win in the short term, mint more OVL, then cash out that OVL, suppressing the value of OVL relative to ETH even more and have more bears win, creating a positive feedback loop.
Caps on open interest and funding rate incentives (for bulls to earn yield on OVL) mitigate this, but it is still a substantial risk. Any users should be well aware of this potential.
The team and community are working on further mechanisms to combat these risks.