Reserve Factor

A Reserve Factor is a parameter used in decentralized lending protocols to determine what portion of the interest paid by borrowers is set aside as a reserve. This reserve acts as a safety buffer for the protocol to cover potential bad debt, protocol deficits, or unexpected losses.

By diverting a percentage of the interest generated by loans into a protocol-owned pool, the system enhances its long-term solvency and sustainability. It is a critical component of risk management in tokenomics, ensuring that the platform can withstand insolvency events without requiring immediate user bailouts.

The specific percentage is typically determined by governance voting based on the protocol risk appetite. Higher reserve factors increase protocol safety but decrease the effective yield earned by liquidity providers.