The Minimum Collateral Ratio (MCR) is the lowest allowable ratio of a position's collateral value to its borrowed value, expressed as a percentage (e.g., 150%). It is a core risk parameter set by protocol governance to ensure the solvency of the lending pool. If a user's collateralization ratio falls below this threshold—typically due to a drop in collateral value or a rise in debt value—their position becomes undercollateralized and is eligible for liquidation. This mechanism protects lenders by ensuring outstanding loans are always over-collateralized under normal market conditions.
LABS
Glossary
Minimum Collateral Ratio (MCR)
The Minimum Collateral Ratio (MCR) is the lowest permissible ratio of collateral value to debt value that a borrower must maintain to avoid liquidation in a decentralized finance (DeFi) lending protocol.
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definition
DEFINITION
What is Minimum Collateral Ratio (MCR)?
The Minimum Collateral Ratio (MCR) is a critical risk parameter in decentralized finance (DeFi) lending and stablecoin protocols, setting the lowest permissible ratio of collateral value to debt value before a position is subject to liquidation.
Protocols like MakerDAO (for the DAI stablecoin) and Aave utilize MCRs, though the specific terminology may vary (e.g., Liquidation Ratio or Liquidation Threshold). The MCR is calibrated based on the volatility and liquidity of the accepted collateral assets; riskier assets require a higher MCR. For example, a pool accepting volatile crypto like ETH might mandate an MCR of 150%, while a pool accepting stablecoins might set it at 110%. This creates a safety buffer to absorb price swings before the liquidation process is triggered.
The Health Factor is a closely related metric that compares a position's current collateralization to the MCR. A Health Factor of 1.0 means the collateral value equals the MCR requirement. When it drops below 1.0, liquidation occurs. Liquidators are incentivized to repay part or all of the undercollateralized debt in exchange for the collateral at a discount, a process that happens via automated smart contracts. This system ensures the protocol remains solvent without requiring a centralized authority.
Setting the MCR involves a trade-off between capital efficiency and security. A lower MCR allows users to borrow more against their collateral but increases systemic risk during market downturns. Conversely, a higher MCR makes borrowing more expensive but strengthens protocol resilience. Governance token holders often vote on MCR adjustments in response to changing market conditions, making it a dynamic parameter central to DeFi's decentralized risk management framework.
key-features
MECHANISM
Key Features of the Minimum Collateral Ratio
The Minimum Collateral Ratio (MCR) is a core risk parameter in overcollateralized lending and stablecoin protocols. These features define its function, enforcement, and impact on system stability.
01
Risk Buffer Definition
The MCR defines the minimum allowable ratio of a position's collateral value to its debt value. For example, an MCR of 150% means a user must maintain at least $1.50 in collateral for every $1.00 of debt. This buffer protects the protocol from losses due to price volatility and liquidation delays.
02
Liquidation Trigger
The MCR serves as the primary liquidation threshold. When a user's collateralization ratio falls below the MCR (e.g., due to a drop in collateral price or an increase in debt), their position becomes eligible for liquidation. This mechanism ensures the protocol remains solvent by closing undercollateralized positions before they become insolvent.
03
Dynamic Parameter Governance
The MCR is not static; it is a governance-controlled parameter. Protocol token holders or a decentralized autonomous organization (DAO) can vote to adjust the MCR for different asset types based on:
- Market volatility
- Liquidity depth
- Historical performance data A higher MCR increases safety but reduces capital efficiency, while a lower MCR has the opposite effect.
04
Asset-Specific Configuration
Protocols typically assign different MCRs to different collateral assets based on their risk profile. A stablecoin like USDC may have a lower MCR (e.g., 110%) due to its price stability, while a more volatile asset like ETH may have a higher MCR (e.g., 150%). This risk-tiering is a fundamental aspect of collateral management.
05
Health Factor & Safety Margin
User interfaces often display a Health Factor, which is the ratio of the collateral value to the debt value relative to the MCR. A Health Factor of 1.0 means the position is exactly at the MCR threshold. Users maintain a safety margin by keeping their Health Factor well above 1.0 to avoid liquidation during market swings.
06
Systemic Stability Role
The aggregate MCR across all positions is a key metric for protocol solvency. It acts as a collective defense against black swan events. By enforcing a minimum overcollateralization, the protocol ensures it can cover bad debt from liquidations, protecting the integrity of minted stablecoins (like DAI) or the lending pool.
how-it-works
DEFINITION & MECHANICS
How the Minimum Collateral Ratio Works
A detailed breakdown of the Minimum Collateral Ratio (MCR), a critical risk parameter in decentralized finance (DeFi) lending and stablecoin protocols.
The Minimum Collateral Ratio (MCR) is the lowest permissible ratio of collateral value to debt value that a user must maintain in a lending or borrowing protocol to avoid liquidation. It is expressed as a percentage (e.g., 150%) and acts as a safety buffer, ensuring the value of the locked assets always exceeds the borrowed value even during market volatility. If a user's collateralization ratio falls below this threshold—typically due to a drop in collateral value or an increase in debt value—their position becomes eligible for forced liquidation by the protocol or other users to repay the debt and protect the system's solvency.
Protocols set the MCR based on the risk profile of the collateral asset. More volatile assets like cryptocurrencies generally require a higher MCR (e.g., 150-200%) to account for sharp price swings, while less volatile or overcollateralized stablecoins may have a lower requirement. This parameter is a cornerstone of risk management, directly influencing the protocol's capital efficiency and stability. A higher MCR makes borrowing safer but less capital-efficient, as it requires more locked value per unit of debt. Governance tokens often allow the community to vote on adjusting these parameters in response to changing market conditions.
From a user's perspective, maintaining a health factor or collateral ratio well above the MCR is crucial. This buffer protects against sudden market downturns. For example, in a protocol with a 150% MCR, a user borrowing $1,000 must lock at least $1,500 worth of ETH. If ETH's price drops, causing the collateral value to fall to $1,400, the ratio becomes 140%, triggering a liquidation event. The protocol will then sell a portion of the collateral at a discount to repay the debt and restore the ratio above the MCR, with the user incurring a liquidation penalty.
The MCR is distinct from the Liquidation Ratio, which is often slightly higher to create a buffer zone before actual liquidation occurs, and the Target Collateral Ratio used in more complex systems like MakerDAO's multi-collateral DAI. Understanding the MCR is essential for assessing borrowing risks, designing robust smart contracts, and analyzing the inherent leverage and stability of any DeFi protocol that relies on collateralized debt positions.
KEY PROTOCOL PARAMETERS
MCR vs. Related Risk Parameters
A comparison of the Minimum Collateral Ratio (MCR) against other core risk management parameters that govern lending and borrowing in DeFi protocols.
| Parameter | Minimum Collateral Ratio (MCR) | Liquidation Threshold | Liquidation Penalty | Loan-to-Value Ratio (LTV) |
|---|---|---|---|---|
Primary Function | Absolute minimum collateral value before liquidation is triggered | Collateral value at which a position becomes eligible for liquidation | Fee charged on the debt or collateral during a liquidation event | Maximum borrowing power against posted collateral at position opening |
Typical Value Range | 110% - 150% | 80% - 85% | 5% - 15% | 50% - 80% |
Trigger Condition | Collateral Value / Debt Value <= MCR | Collateral Value / Debt Value <= Liquidation Threshold | Executed when a position is liquidated | Used to calculate Max Borrow: Collateral Value * LTV |
Impact on User | Position is immediately liquidatable if breached | Position enters a state where keepers can trigger liquidation | Increases the cost of being liquidated for the borrower | Determines initial borrowing capacity and safety buffer |
Relationship to MCR | The final, non-negotiable line | Always set at a higher collateral ratio than the MCR to create a buffer | Applied when the MCR is breached and liquidation occurs | Inverse relationship; a lower LTV creates a larger buffer before hitting the MCR |
Common Synonym | Liquidation Ratio, Minimum Collateralization Ratio | Liquidation LTV, Call Threshold | Liquidation Bonus (for liquidators) | Maximum LTV, Collateral Factor |
Protocol Control | Set by governance or risk teams; immutable per asset | Set by governance or risk teams; can vary by asset | Set by governance; can be a fixed fee or dynamic | Set by governance or risk teams; primary risk setting |
User Control | Cannot be modified; must maintain ratio above it | Cannot be modified; must maintain ratio above it | Cannot be avoided if liquidation occurs | Chosen by user up to the protocol's maximum limit |
examples
COMPARATIVE ANALYSIS
MCR Examples in Major Protocols
The Minimum Collateral Ratio (MCR) is a critical risk parameter that varies significantly between protocols, reflecting different design philosophies and asset risk profiles.
security-considerations
MINIMUM COLLATERAL RATIO (MCR)
Security Considerations & Risks
The Minimum Collateral Ratio (MCR) is a critical risk parameter in overcollateralized lending protocols that defines the lowest permissible ratio of collateral value to debt value before a position is subject to liquidation.
01
Liquidation Threshold
The MCR acts as the precise threshold that triggers a liquidation event. When a user's collateralization ratio falls below this level due to price volatility, the protocol's liquidation engine automatically auctions the collateral to repay the debt, protecting the system's solvency.
- Example: With an MCR of 150%, a $150 ETH-backed loan becomes liquidatable if the ETH value drops below $225.
- The gap between the initial collateral ratio and the MCR is the user's safety buffer.
02
Parameter Governance Risk
The MCR is a mutable parameter typically controlled by a decentralized autonomous organization (DAO) or core developers. Sudden, unannounced changes to the MCR can have severe consequences:
- Risk of Instant Liquidation: A sharp increase in the MCR can immediately push many positions below the new threshold.
- Governance Attacks: Malicious actors may attempt to manipulate governance to alter MCR for profit or to destabilize the protocol.
- Users must monitor governance proposals related to risk parameters.
03
Oracle Dependency & Manipulation
The MCR is enforced based on oracle price feeds. The security of the entire mechanism depends on the accuracy and manipulation-resistance of these oracles.
- Oracle Failure: A stale or incorrect price can cause unjust liquidations or, conversely, fail to liquidate insolvent positions.
- Flash Loan Attacks: Attackers can use flash loans to temporarily manipulate an asset's price on a DEX to trigger mass liquidations on a lending protocol.
- Protocols mitigate this with time-weighted average prices (TWAPs) and multiple oracle sources.
04
Liquidation Incentives & Slippage
When liquidation occurs, liquidators are incentivized with a discount (liquidation penalty) on the collateral. The design of this mechanism poses risks:
- Insufficient Incentive: If the liquidation bonus is too low, liquidators may not act, allowing bad debt to accumulate.
- Excessive Penalty: A penalty that is too high overly punishes the liquidated user and can lead to liquidation spirals in volatile markets.
- Slippage Risk: Large liquidations in illiquid markets can cause significant price impact, resulting in bad debt for the protocol if the auction fails to cover the loan.
05
Cross-Protocol Contagion
An MCR breach and subsequent large-scale liquidation on one major protocol can trigger cascading effects across DeFi:
- Fire Sale Dynamics: Mass selling of collateral can depress the asset's price, pushing positions on other protocols below their MCRs.
- Example: The 2022 UST/LUNA collapse demonstrated how de-pegging and liquidations can propagate systemic risk.
- This interlinked risk underscores the importance of stress testing MCR levels against extreme market scenarios.
06
Health Factor vs. MCR
While MCR is a global protocol parameter, a user's Health Factor (HF) is the individual metric for their position. It's calculated as (Collateral Value * Collateral Factor) / Borrowed Value.
- Key Relationship: A Health Factor dropping below 1.0 means the position is below the protocol's effective liquidation threshold (which is derived from the MCR and other factors).
- Monitoring Tool: Users track their HF in real-time; it is the primary dashboard indicator of liquidation proximity.
- The Collateral Factor (or Loan-to-Value ratio) is a separate, related parameter that determines borrowing power.
DEBUNKED
Common Misconceptions About MCR
The Minimum Collateral Ratio (MCR) is a critical risk parameter in DeFi lending, yet it is often misunderstood. This section clarifies the most frequent points of confusion.
No, the Minimum Collateral Ratio (MCR) is not a fixed or universal number; it is a dynamic, protocol-specific risk parameter set by governance. The MCR varies significantly based on the collateral asset's volatility, liquidity, and the protocol's risk tolerance. For example, a stablecoin like USDC might have an MCR of 110% on a conservative platform, while a more volatile asset like ETH could have an MCR of 150% or higher. Furthermore, protocols like MakerDAO can adjust MCRs for individual collateral types (Vault Ilks) through executive votes in response to market conditions. Assuming all MCRs are the same is a critical error in risk assessment.
MINIMUM COLLATERAL RATIO
Frequently Asked Questions (FAQ)
Essential questions and answers about the Minimum Collateral Ratio (MCR), a critical risk parameter in overcollateralized DeFi lending and stablecoin protocols.
The Minimum Collateral Ratio (MCR) is the lowest permissible ratio of a position's collateral value to its debt value, expressed as a percentage, before it becomes eligible for liquidation. For example, an MCR of 150% means a user's collateral must be worth at least 1.5 times their borrowed amount. This parameter is a core risk management mechanism that protects lenders and protocol solvency by ensuring all outstanding loans are sufficiently backed by assets that can be sold to cover the debt if the borrower defaults. It is a protocol-level constant set by governance, distinct from a user's actual Collateral Ratio.
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