Haircut Methodology

Haircut methodology refers to the systematic process of discounting the value of an asset used as collateral to provide a safety buffer against price volatility. For example, if an asset is worth 100 dollars but has a 20 percent haircut, it will only be valued at 80 dollars for the purpose of calculating margin.

This ensures that even if the asset price drops significantly, the protocol still has sufficient collateral to cover the debt. The size of the haircut is determined by the asset's volatility, liquidity, and overall risk profile.

More stable assets receive smaller haircuts, while riskier, more volatile assets receive larger ones. This methodology is essential for protecting the protocol's solvency and managing systemic risk.

Traders must be aware of these haircuts as they directly affect the amount of borrowing power they have for a given amount of collateral. It is a core risk management tool that allows for a tiered approach to collateral quality.