Collateral Caps

Minimizing systemic risk

Collateral Caps in Curvance

Collateral caps are used as a core safeguard for the lending markets, setting specific restrictions on the amount of each asset that can be used as collateral. This mechanism is essential for protecting the protocol against bad debt and unintentionally incentivizing market manipulation by bad actors.

Purpose and Function of Collateral Caps

While the protocol allows unlimited vault deposits to earn yield, only a percentage of total assets in each market can be used as collateral for borrowing. By setting these collateral caps, the Curvance protocol minimizes the risks posed by market volatility and sudden price shifts, aligning with industry risk management principles to ensure the platform’s stability.

• Mitigating Overexposure: Collateral caps prevent overexposure to specific assets within isolated markets, reducing potential adverse impacts during volatile market conditions.

• Ensuring Controlled Borrowing: Collateral caps create an over-collateralized borrowing environment, mitigating systemic risk while providing users with a secure lending and borrowing experience.

Determining Collateral Caps

Collateral caps are determined by a third-party risk management group elected by Curvance DAO participants known as the Curvance Collective. These caps are based on an asset’s on-chain liquidity across various pairs within the network. The elected third party also evaluates offside liquidity (liquidity distributed across asset pairs within the protocol) and sets caps to ensure stability.

Example: If USDY constitutes 80% of a skewed stable pool, with USDC making up 20%, the collateral cap for USDY is calculated based on USDC’s liquidity. If total offside liquidity is $10 million (with $8 million in USDY and $2 million in USDC) and Curvance allows a cap of 40% of offside liquidity, the collateral cap would be 40% of $2 million, or $800,000, translated into tokens based on asset value.

DAO-Controlled Updates

Shortly after the Curvance DAO launches, the Curvance Collective will vote to select their preferred third-party risk management group. This group will be tasked with determining risk parameters for all supported assets. Together, the Curvance DAO and the elected group will regularly review and adjust collateral caps in response to changes in offside liquidity, ensuring alignment with on-chain liquidity. This dynamic approach to risk management helps mitigate systemic risks and maintain stability within the protocol's lending markets.

Collateral Cap Example: On-Chain Liquidity Focus

Consider $100 million in sDAI within the Curvance protocol, earning native gauge emissions. With a focus on on-chain liquidity, the protocol caps collateralization for sDAI at approximately 10 million tokens. This cap means that no more than 10 million sDAI can be used as collateral, ensuring controlled asset exposure while minimizing systemic risk.

By carefully linking collateral caps to liquidity dynamics and adjusting them via DAO governance, the protocol can provide a robust, stable approach to collateralized borrowing. This method aligns user security with broader protocol health, allowing users to scale responsibly within DeFi.