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The leverage thresholds dictate the maximum proportion at which the nToken account can provide liquidity for each liquidity pool by market index. If, during the course of minting nTokens, a liquidity pool’s proportion is greater than its leverage threshold, the nToken will lend to that liquidity pool with its allotted cTokens instead of providing liquidity.
The purpose of the leverage threshold is to ensure that an nToken account does not become undercollateralized by providing liquidity to individual liquidity pools at leverage ratios that are too high. Leverage thresholds also aim to lower interest rates by lending when a pool's proportion becomes abnormally high.
As nToken accounts can’t have negative free collateral values, we must ensure that the highest possible interest rate at which the nToken account can provide liquidity (the leverage threshold) would allow the nToken account’s free collateral value to remain positive even if interest rates decreased from the leverage threshold to 0% in infinitesimal trading increments without any passage of time.
Our leverage threshold selection process relies on simulations to validate the robustness of the selected parameters.
We selected leverage thresholds optimizing for the following properties:
- the nToken accounts should never become undercollateralized;
- the leverage thresholds implied interest rates are situated above the estimated interest rate ranges (see anchor rates section).
We estimate that leverage thresholds implying interest rates of ~6% and ~7% are likely to be adequate for crypto asset and stablecoin pairs respectively:
Based on the selected AMM curves, we simulated the maximum leverage thresholds at which an LP still has a positive free collateral position after an instant decrease in interest rates from the leverage threshold to 0%. The following simulation results validate that the selected leverage thresholds are sufficiently low (the selected leverage thresholds are lower than the maximum proportions at which interest rates can decrease to 0% without an LP account having a negative free collateral position) to protect the nToken accounts against such an event: