nTokens

This section covers nToken governance parameters as a collateral type.

nTokens governance parameters

nTokens are ERC20 assets that are redeemable for a share of Notional’s total liquidity in a given currency across all active maturities. nToken accounts hold a basket of cTokens, liquidity tokens, and fCash. Learn more about nTokens here.

The value of nTokens is thus a function of the value of the cTokens, fCash assets and liquidity tokens an nToken account holds. It is important to note that nTokens do not monotonically increase in value over time.

If an nToken holder borrows against its nTokens and they subsequently decrease in value, the nToken holder's account could become undercollateralized and eligible for liquidation.

The size of the move in the value of nTokens that the protocol can withstand and the liquidation discounts used to attract liquidators are dictated by the nToken PV Percentage and the nToken Liquidation Haircuts respectively.

nToken liquidation haircuts

nToken liquidation haircuts are applied to the nToken PV to calculate its purchase price in the course of a liquidation.

Purpose of the nToken liquidation haircut percentage

The liquidation haircut percentage acts as an incentive for liquidators to recapitalize accounts with collateral requirements. Thus, the liquidation haircut percentage should cover the expected trading costs associated with the liquidation of an nToken position and provide a sufficiently large additional premium as a liquidation incentive for liquidators.

Selected parameters

We selected the following liquidation haircut percentages:

Cash Group	nToken liquidation haircut percentage
Stablecoins
USDC	97% or 300 bps discount
DAI	97% or 300 bps discount
Crypto assets
ETH	98% or 200 bps discount
WBTC	98% or 200 bps discount

In our opinion, the expected trading costs (gas fees and bid-ask spread) associated with the liquidation of nTokens and the premium needed to reliably attract liquidators should be ~200-300 BPS.

nToken PV Haircut Percentage

The nToken Haircut Percentages are applied to the nToken PV in the course of the free collateral calculation.

Purpose of the nToken PV Haircut percentage

The purpose of the PV haircut percentage is to mitigate the risk the protocol could face from a decrease in the collateral value of nTokens.

The PV haircut percentage allows Notional’s governance to mitigate this under collateralization risk by applying a haircut to the value of nTokens thus recognizing only part of their value as collateral. Haircuts increase Notional’s ability to withstand the liquidation of a liquidity provider’s nTokens if its account free collateral value turns negative as a consequence of a sudden change in interest rates.

The PV haircut percentage also acts as a limit to the amount of leverage liquidity providers can take.

Selected parameters

The selected PV haircut percentages aim to maximize the likelihood of an orderly liquidation process and to protect the protocol against a rapid decline in the value of nTokens.

To protect the protocol against the worst possible decline in the value of nTokens, the PV haircut percentage should be larger than the sum of the liquidation haircut percentage and the maximum possible decrease in the value of nTokens (-10% for nUSDC & nDAI and -5% for nETH and nWBTC). Moreover, in order to limit the amount of leverage in the system, we believe it is prudent to adopt a lower nToken PV haircut percentage. Taking into account the liquidation haircut percentage (see liquidation Haircut Percentage section) and the worst possible nToken loss results, we selected the following PV haircut percentages:

Cash Group	nToken PV haircut percentage
Stablecoins
USDC	0.85
DAI	0.85
Crypto assets
ETH	0.90
WBTC	0.90