Collateralization Ratio (C-Ratio)

When a position's C-Ratio breaches the protocol's minimum, liquidation occurs. Key models include:

• Fixed Discount (Aave, Compound): Liquidators buy collateral at a set discount.
• Dutch Auction (MakerDAO): Collateral price decreases until a buyer is found.
• Stability Pool (Liquity): A pool of stablecoins is used to repay debt, distributing collateral to pool participants. Liquidations are essential for maintaining the protocol's solvency and the peg of minted assets.

The Collateralization Ratio (C-Ratio) is the value of a user's locked collateral divided by the value of the debt they have minted or borrowed, expressed as a percentage. A C-Ratio of 150% means the collateral is worth 1.5 times the debt. This overcollateralization is fundamental to mitigating counterparty risk in permissionless systems.

• Formula: (Value of Collateral / Value of Debt) * 100%
• Example: $15,000 in ETH collateral backing a $10,000 DAI loan has a C-Ratio of 150%.

Protocols set a minimum collateralization ratio (e.g., 110% for MakerDAO's ETH-A vault). If the C-Ratio falls below this threshold due to collateral value dropping or debt increasing, the position becomes eligible for liquidation. Liquidators can purchase the undercollateralized assets at a discount, repaying the debt to keep the system solvent. This mechanism protects lenders and maintains the peg of algorithmic stablecoins.

In protocols like Aave and Compound, the inverse concept is the Health Factor (HF), calculated as (Collateral Value * Liquidation Threshold) / Borrowed Value. A Health Factor below 1.0 triggers liquidation. Users must actively manage their C-Ratio/Health Factor by:

• Adding more collateral
• Repaying part of the debt
• Using debt monitoring tools and automation to avoid unexpected liquidations during market volatility.

Some protocols use the C-Ratio as a dynamic parameter for fee structures. In Synthetix, users staking SNX to mint synthetic assets (synths) must maintain a target C-Ratio (e.g., 400%). Falling below it incurs penalties and restricts fee rewards, while being above it optimizes rewards. This creates a game-theoretic incentive for stakers to self-regulate and keep the system adequately collateralized.

The C-Ratio is only as reliable as the price oracles that determine the value of the collateral and debt assets. Manipulation of these price feeds (e.g., via flash loan attacks) can artificially lower the perceived C-Ratio, triggering unjust liquidations. This is a critical oracle risk. Robust protocols use decentralized oracle networks (like Chainlink) and time-weighted average prices (TWAPs) to mitigate this vulnerability.

Different DeFi protocols implement C-Ratio mechanics with varying parameters and consequences:

• MakerDAO: Asset-specific minimum C-Ratios (e.g., 110% for ETH, 170% for WBTC) and stability fees.
• Liquity: A fixed minimum C-Ratio of 110%, with a Stability Pool as the primary liquidation mechanism.
• Synthetix: A high target C-Ratio (e.g., 400%) for stakers, with rewards and penalties tied to compliance. Understanding these design choices is key to assessing protocol risk.

The forced sale of a borrower's collateral when their Collateralization Ratio falls below a protocol's Liquidation Threshold. This process is automated by smart contracts or Keepers to repay the outstanding debt and protect the protocol from insolvency. Key aspects include:

• Liquidation Penalty: A fee charged to the borrower, incentivizing keepers.
• Liquidation Price: The asset price at which a position becomes eligible for liquidation.
• Health Factor: A similar metric used by protocols like Aave to represent liquidation risk.

The lowest permissible Collateralization Ratio a borrower can maintain before their position is flagged for Liquidation. It is a critical protocol parameter set by governance. For example:

• In MakerDAO, the Minimum Collateralization Ratio for an ETH-A vault is 145%.
• Borrowers must maintain a C-Ratio above the MCR to avoid liquidation.
• The MCR acts as a buffer, accounting for price volatility and liquidation inefficiencies.

The practice of locking collateral worth more than the value of the debt issued, which is fundamental to most DeFi lending. It mitigates the risk of undercollateralization due to asset volatility. Examples include:

• MakerDAO's DAI: A user locks $150 of ETH to mint $100 of DAI (150% C-Ratio).
• Compound & Aave: Users supply assets as collateral to borrow a smaller value of other assets.
• This creates a capital efficiency trade-off versus undercollateralized or algorithmic models.

A protocol-level limit on the total amount of debt that can be issued against a specific type of collateral. It works in tandem with the Collateralization Ratio to manage systemic risk. Key functions:

• Risk Isolation: Limits exposure to a single collateral asset.
• Governance Control: Adjusted via DAO votes based on asset risk profiles.
• In MakerDAO, each Vault Type (e.g., ETH-A, WBTC-A) has its own debt ceiling.

The interest rate charged on debt generated in an overcollateralized system, such as a MakerDAO Vault. It is distinct from the Collateralization Ratio but interacts with it financially.

• Paid in the protocol's stablecoin (e.g., DAI) or governance token (MKR).
• Accrues over time, increasing the total debt owed.
• A rising debt balance can lower the C-Ratio, pushing a position closer to liquidation if collateral value doesn't increase.

Often used synonymously with Minimum Collateralization Ratio (MCR), it is the threshold ratio at which liquidation is triggered. It is calculated as: (Collateral Value / Debt Value) * 100 = X% If X% ≤ Liquidation Ratio, the position is undercollateralized. This parameter is asset-specific, with riskier collateral types (e.g., volatile altcoins) assigned higher ratios to provide a larger safety buffer.