Supply Cap

Definition

Notional supply caps dictate the maximum amount of tokens that can be supplied to the protocol.

Supply caps should generally be set as a function of:

• User demand for the onboarded asset;

• The onboarded asset's liquidity profile;

• The onboarded asset's volatility profile.

Supply Cap initial selection process

Step 1 - Gather historical trading and liquidity data

Using the asset onboarding spreadsheet template gather historical trading volume data, current slippage data from a DEX aggregator, and current on-chain liquidity data.

Step 2 - Select a Supply Cap based on the asset's on-chain liquidity profile

Based on the available data, determine a Supply Cap that aligns with on-chain liquidity. In practice, this means a Supply Cap where the protocol could liquidate an account holding a large portion of the Supply Cap as collateral (ex: 25% or 50% of the Supply Cap) for USDC without incurring slippage above the asset's liquidation discount. Note, that it is highly unlikely that the entirety of the Supply Cap would be liquidated over a short period of time if the supplier user base is sufficiently diversified. Moreover, liquidators can also liquidate an account partially if necessary.

To ensure the Supply Cap is appropriate, validate that the initial Supply Cap checks the following conditions:

• Supply Cap < 5% of the asset's circulating supply;

• Supply Cap <= $5M

• Supply Cap <= 50% on-chain liquidity (non-asset based liquidity)

These checks are in place to limit the protocol's exposure to the onboarded asset. These checks aim at maximizing the likelihood of successful liquidations.

Other considerations

An asset's Supply Cap should always be set conservatively initially. Supply Caps can always be increased by Notional's governance if demand is high and as market conditions change. Using more conservative Supply Caps initially allows governance to analyze how a market's supply concentration evolves over time. For example, suppose only one account holds a position the size of the entire Supply Cap. In that case, governance might not be as keen to raise the Supply Cap compared to a case where a large base of users are supplying the asset. A large supplier base is more likely to diversify an asset's liquidation prices, thereby reducing the asset's risk profile for the protocol.

Moreover, Supply Caps that are kept relatively close to an asset's supply demand can potentially mitigate the risk of flash-loan based attacks on the protocol.

Step 3 - Benchmark the Supply Cap against other lending protocols

Validate that the selected supply cap aligns with other lending protocols and is not overly aggressive.