Collateral Cap

What is Collateral Cap?

A collateral cap is a security measure intended to spread out lending risk over the entire protocol and away from any single asset. It establishes a market's maximum effective collateral, expressed in units of the relevant token, and serves as a means of measuring and regulating the “borrowing power” of each asset.

A market's collateral cap, for instance, might be set at 1 million tokens, meaning that only 1 million of that token can be pledged as collateral for loans.

This aids in lowering systemic risks brought on by individual assets, particularly those posed by assets with poor on-chain liquidity. Imagine that a protocol called for the seizure of an asset after depleting the provided collateral. Due to a lack of on-chain liquidity, it might not be able to be changed into another asset or traded for another asset.