Default Risk Allocation

Default risk allocation is the process of determining how the losses from a loan default are distributed among the various participants in a lending protocol. This can involve prioritizing the use of insurance funds, followed by the protocol solvency buffer, and finally, if necessary, the socialization of losses among lenders.

The allocation model defines the hierarchy of risk and ensures that losses are handled in a predictable and orderly manner. A well-designed allocation framework provides transparency and stability, which is crucial for attracting capital to the protocol.

It is a central element of the protocol's economic design and governance structure. Understanding this allocation is essential for all participants to comprehend their potential liabilities in the event of systemic stress.