Collateralization

Notional treats each asset differently during the free collateral calculation and applies the Collateral Factor or Borrow Factor to each asset's value as a function of its riskiness. This Collateral Factor and Borrow Factor 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.

Note that this parameter is fixed and can't be changed by governance.

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When the collateral value and the debt value are the same, the system recognizes that particular account to be under water.

Notional computes the LTV (loan to value) ratio to verify if an account is eligible for liquidation. To calculate the LTV ratio Notional adjusts the collateral value with the collateral factor which reduces the value of collateral in the computation of LTV. Similarly, Notional adjusts the debt value with the borrow factor which increases the value of the debt in the computation of LTV.

With the above adjustments, the ratio of adjusted debt and adjusted collateral turns out to be greater than one. This is equivalent to insolvency, so whenever an account's adjusted LTV is greater than 1 that account is eligible for liquidation.

For the adjusted LTV to be at the point of liquidation i.e. adjusted LTV = 1, either the debt needs to be lowered or the collateral needs to be increased. In the above case, we decrease the debt.

When we decrease the debt or increase the collateral there comes a point where the adjusted debt and the adjusted collateral turn out to be equal at this point the ratio between the actual debt and collateral is the maximum allowed LTV and if the LTV increases beyond this point the account would get liquidated.

The above scenario is an ideal scenario where the LTV is below the maximum LTV ratio (adjusted LTV ratio less than 1) such that the position can be managed to avoid liquidation from small market movements.

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