Protocol and token parameters for Hundred Finance
Lending protocols have inherent risks associated with the price volatility of assets typically used on such platforms. In order to mitigate these risks, the amount of debt a borrower is allowed to take on is less than the value of the deposit supplied to the protocol, a concept known as over collateralization. An asset deposited onto the platform will have a Collateral factor (CF), which designates the amount of the asset’s value that can be used to collateralize borrowing. Stablecoins, which have little price volatility, generally have high collateral factors and are thus commonly used for borrowing. Volatile assets, on the other hand, may have lower collateral factors to mitigate volatility and reduce the chance that a borrower’s account becomes under-collateralized. Each asset of a protocol is assigned its own parameters based on its individual risk profile and the objectives of those who govern the protocol and seek to ensure its solvency through minimal reliance on liquidations.
- Debt (D): Capital temporarily acquired from a lending pool and secured by supplying collateral.
- Interest rate (IR): A time-based increase or decrease in the value of supplied or borrowed assets, expressed as a percentage. The amount accrued over time is a function of demand for that asset and the available supply.
- Collateral (C): Assets supplied by a borrower with a collateral factor sufficient to carry out a borrow/secure a debt.
- Collateral factor (CF): The percentage of an asset’s value that can be drawn as a borrow against it.
- Liquidation Threshold (LT): The maximum percentage of an asset value that can be borrowed against the asset.
- Close Ratio (CR): The maximum ratio of a debt that can be repaid in a single liquidation event.
- Collateralization Ratio (CR): Ratio between the total value of collateral and the total value of debt.
- Borrowing Capacity (BC): Total amount a borrower can request from a lending pool based on the collateral factor of each pool.
- Health factor (HF): Indicator of borrowing capacity against debt.
- Liquidation incentive (LI): Is the bonus, or discount, that a liquidator can collect when liquidating collateral. This spread incentivizes liquidators to liquidate a loan as soon as it crosses the liquidation threshold (LT).
The borrower of an asset is required to supply collateral, where the total value of the supplied collateral exceeds the total value of the borrowed asset (Debt).
The debt is good as long as the collateral is worth more than the amount borrowed, as measured by the Health factor (HF). For example: a borrower supplies 1000 USD worth of ETH and can thus borrow a maximum of 800 USD worth or USDC (fixed assumption 1 USD = 1 USDC). The collateral factor for the asset ETH being 80%.
The total amount of the borrow that can be taken against security deposits is the Borrowing capacity (BC).
The Health Factor (HF) is defined as the ratio of the total borrowed, against the borrow capacity.
When HF < 1, the position is under-collaterized and is eligible for liquidation.
It is very important to understand that a debt taken out with a Collateral factor (CF) equal to the maximum allowed by asset exposes the debtor to an imminent risk of being liquidated given that rapid price drops can occur.
The price data feed is secured by Chainlink oracles that are being updated either once every 24 hours (in general) or when the difference between the last price and a new price exceeds the heartbeat threshold as shown in table2 (Chainlink Price Data feed).
Therefore, the bigger the spread between the Loan-to-Value (LTV) and the Collateral Factor (CF), the less the debtor is exposed to price drops.
Table 1 below shows the spread and the respective price drop of the collateralized asset before it gets to a point of being liquidated. The example exhibits a case where the liquidation threshold (colFactor) equals 80%, but applies to other factors as well.
The delta price change allowed to keep the debt healthy before a liquidation occurs is:
Table 1. collateral Factor Ratio and Price Change
Chart 1. Collateral Factor Ratio and Price Change
- Deposit 10 ETH at a 4000 USD price Collateral Factor (CF) = 80% Maximum amount to borrow = 32000 USD Borrow (Debt)20000 USDC at 1 USD price Loan-to-value (LTV) = 40% CF Ratio = 50% / 80 % = 62,50% HF = 32000 / 20000 = 1,6 > 1
- If the price of ETH drops below the safe maximum -37,50% then the position is eligible for liquidation.
- ETH price = 4000 *(1 -37,51%) = 2499,6 The borrow capacity BC = 2499,6 * 10 * 80% = 19996,8 The health factor is HF = BC / Debt = 19996,8 / 20000 = 0,99984 < 1