Collateral Haircut Calibration

Collateral haircut calibration is the process of determining the percentage discount applied to an asset's market value when it is used as collateral. This discount accounts for the asset's historical volatility, liquidity, and the risk that it may be difficult to sell during a crisis.

By applying a haircut, the lender ensures that they are protected even if the collateral's price drops significantly. Proper calibration is critical in the crypto sector, where assets can experience double-digit percentage drops in a single day.

If the haircut is too low, the lender is exposed to the risk of the collateral becoming worth less than the loan. If it is too high, it unnecessarily restricts capital efficiency.

Calibration involves analyzing price distributions and liquidity depth to ensure the discount is appropriate for the asset's specific risk profile.