Secured Finance Deep Dive series

Minimum Collateral Threshold

Essential Safe Guard for DeFi Orderbook Loan

Kenji Mitsusada

Published in

Secured Finance

4 min readOct 16, 2023

Introduction

In this article, we’ll explore an advanced risk management feature we’ve recently rolled out: the Minimum Collateral Threshold. This feature is crucial for lenders, borrowers, and protocol and aims to fortify the robustness of our financial ecosystem.

The Landscape of Collateral in Finance

In traditional finance, creditworthiness often dictates the terms of a loan, including interest rates. However, the DeFi landscape operates differently. Given the absence of a credit system, borrowers are required to over-collateralize their loans. This is where our new feature comes into play.

The Nuts and Bolts of Secured Finance

Secured Finance is not just another DeFi platform; we specialize in bond trading, particularly zero-coupon bonds. Borrowers issue these bonds to raise capital. Lenders buy these bonds, effectively loaning out their money, with the promise of being repaid the principal along with accrued interest at a future date.

Loan-to-Value (LTV) and Liquidation

On our platform, the Loan-to-Value (LTV) ratio is capped at 80% for borrowers. If the LTV exceeds this limit, the system triggers a liquidation event, forcing the sale of the borrower’s collateral to repay the loan with penalty.

Addressing Vulnerabilities

Despite the robustness of DeFi protocols, vulnerabilities can still occur. For a deeper dive into some of the challenges we’ve faced and addressed, refer to this article.

Introducing the Minimum Collateral Threshold

To further enhance security, we’ve introduced the Minimum Collateral Threshold. Unlike a flat LTV ratio, this feature recalculates the present value of collateral based on its future value and a set threshold under certain conditions. Importantly, this threshold is only applicable to borrowers, not lenders or those who unwinding against their existing lending position.

Case Study: The Impact of Bond Prices on Collateral

This threshold is applied only for the borrowers when the zero-coupon bond market is trading below the base price which is pre-set depend on the currency. Please refer to our official document for the currency categorisation.

Normal Situation

Let’s consider a borrower who wants to borrow $100,000 for one year in a Category B currency at a bond price of 94.00. In this case, he would need to pledge at least $125,000 worth of collateral before placing a borrowing order, as the Loan-to-Value limit is 80% (100,000/125,000).

Special Situation: Bond Price Below Base Price

What happens if he wants to borrow the same amount when the bond price is at 50.00?

In this situation, he is trying to borrow $100,000 as Present Value (PV), while his Future Value (FV) obligation will be $200,000, which he needs to repay after one year. Normally, as in the case above, he would only need to pledge $125,000 as collateral based on PV.

However, this bond price of 50.00 is lower than the base price for one year for Category B, which is set at 91.00. Now, he needs to pledge more collateral based on his future obligation amount along with our base price.

His obligation of $200,000 is worth $182,000 as adjusted PV when calculated with the minimum collateral base rate (200,000 * 91.00 / 100). Against this, he needs to pledge collateral. Therefore, the required collateral will be $227,500, calculated as 182,000 / 80%, to place the borrowing order of $100,000 at 50.00.

Conclusion

The Minimum Collateral Threshold is more than just a groundbreaking feature; it’s a pivotal safety mechanism engineered to protect the cornerstone of our ecosystem: the lenders. By ensuring that borrowers are adequately collateralized, we significantly mitigate the risks of insolvency and unauthorized reserve fund outflows.

But the benefits don’t stop there. This feature also serves a larger purpose: it fosters sustainable growth for our protocol. By creating a more secure lending environment, we not only instill greater confidence among lenders but also attract more borrowers. This virtuous cycle of trust and security amplifies the overall health and growth of the Secured Finance ecosystem.

In essence, it’s a triple win: borrowers access the capital they need, lenders invest with greater peace of mind, and the Secured Finance protocol itself enjoys sustainable growth.

For any further questions or clarifications on how the Minimum Collateral Threshold is revolutionizing the Secured Finance platform, feel free to reach out.

About Secured Finance

Secured Finance is revolutionizing the digital asset landscape by constructing interbank-grade capital markets. Our innovative protocol is designed to offer a secure, flexible, and scalable fixed-income solution for digital assets. Comprised of a team of expert investment bankers, we are committed to integrating traditional finance wisdom into the realm of cryptocurrency and digital assets.

Stay informed and connected with us for further information and updates.