Overcollateralization structure

Collateral assets

To ensure the solvency of the system, borrowers using Notional V3 need to overcollateralize their borrowing positions (Prime Debt or negative fCash) against one or a combination of the following collateral asset types:

• Prime Cash (Variable Rate Lending Position)

• Positive fCash (Fixed Rate Lending Position)

• nTokens (LP Position)

Free collateral

Notional uses the concept of free collateral to evaluate an account's collateral position and validate that its debts are sufficiently overcollateralized.

Free collateral represents the amount of excess risk-adjusted collateral, denominated in ETH, that an account holds beyond what it needs to meet its minimum collateral requirements. If an account’s free collateral figure is positive, the account is adequately collateralized. If the account's free collateral figure is negative, it is under-collateralized and eligible for liquidation.

Healthscore

Based on the Free Collateral measure, we can also compute an account's healthscore. The account healthscore is based on the following formula:

If an account's healthscore goes below 1.0 the account becomes eligible for liquidation.

Purpose of collateral assets governance parameters

Each asset has a different risk and liquidity profile. If the value of an account's collateral decreases or the value of its debts increases, the protocol could accrue bad debts.

To mitigate such a risk, Notional treats each asset differently during the free collateral calculation and applies haircuts or buffers to each asset's value as a function of its riskiness. These haircuts and buffers protect the protocol against a rapid decrease in an account's net collateral value if it arises before its collateral assets can be properly liquidated.

More specifically, the Notional protocol implements:

• Currency-specific haircuts and buffers to protect the protocol against a user's cross-currency risk exposure. For example, a user holding Prime ETH collateral against a Prime USDC debt is exposed to the ETH/USDC cross-currency risk.

• Asset-specific haircuts and buffers to protect the protocol against a potential changes in Notional asset prices. For example, a user holding nETH collateral against an fETH debt is exposed to interest rate risk.