Over-Collateralization Modeling

Over-Collateralization Modeling is the quantitative analysis used to determine the minimum ratio of collateral to debt required to maintain system safety. It involves assessing the volatility and liquidity of the collateral asset to ensure that even during extreme price drops, the value of the collateral exceeds the debt.

By setting these requirements appropriately, the protocol builds a buffer against insolvency. This modeling takes into account historical data, tail risk, and potential market correlation.

It is the primary defense against the risk of bad debt. Different assets require different collateral ratios based on their specific risk profiles.

Maintaining this balance is essential for the sustainable operation of any decentralized lending or derivative platform. It provides the foundation for trust in the system.