How Notional stays solvent

A 🧵 on how @NotionalFinance adjusts risks for debt and collateral such that it can stay solvent.

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Notional checks if an account is underwater through their free collateral calculation.

Free collateral is the amount of excess value in your account that can be used to borrow more funds or withdraw as cash. It depends on the type and value of the assets you hold

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Notional is supporting fixed-rate Lending & Borrowing in 4 currencies with the following maturities:

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In any given conditions, a user's portfolio might consist of a combination of +fCash, -fCash, Cash, and nTokens subjected to multiple assets.

Here is a table that shows the user position interpretation w.r.t their asset holdings:

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There are three main types of assets on Notional:

+fCash, -fCash, and nTokens.

+fCash is a claim to future cash flows, -fCash is a debt obligation to pay future cash flows, and nTokens are liquidity provider tokens that earn fees and interest.

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If you hold +fCash or nTokens, you are lending funds and earning interest. These assets are considered net positive (+) in the free collateral calculation, meaning they increase your borrowing capacity.

If you hold -fCash, you are borrowing funds and paying interest. This asset is considered net negative (-) in the free collateral calculation, meaning it decreases your borrowing capacity.

You can also hold Cash in your portfolio, which is neutral (0) in the calculation.

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To ensure the safety and solvency of the system, Notional applies haircuts and buffers to the assets in your portfolio.

✂️ Haircuts (collateral factor) reduce the value of net positive assets, while 🔋buffers (buffer factor) increase the value of net negative assets.

Haircuts and buffers depend on the risk profile of each asset.

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For example, +fCash with longer maturity or higher volatility will have higher haircuts than +fCash with shorter maturity or lower volatility.

Similarly, -fCash with longer maturity or higher volatility will have higher buffers than -fCash with shorter maturity or lower volatility.

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To calculate your free collateral, Notional sums up the net value of each asset in your portfolio after applying haircuts and buffers.

If the result is positive, you have free collateral. If the result is negative, you are undercollateralized and at risk of liquidation.