Collateral Cap

Collateral cap is a risk management mechanism that aims to distribute lending risk across multiple assets within a protocol.

Collateral cap is a security feature designed to diversify protocol-wide lending risk away from any one asset.

What Is Collateral Cap?

Collateral cap is a security feature designed to diversify protocol-wide lending risk away from any one asset. It specifies a market’s maximum effective collateral, measured in units of the respective token, and is a way to allow the ‘borrowing power’ per asset to be measured and limited.

For example, if a market’s collateral cap is set to 1 million tokens, then only 1 million of that token can be used as collateral for borrowing.

This helps to reduce systemic risks created by single assets, especially risks brought by assets with lower on-chain liquidity. For example, if a protocol were to seize an asset from liquidating the collateral provided, it might not be able to be converted or swapped into other assets due to the lack of on-chain liquidity. 
In other words, collateral cap is a per-token setting to control and limit protocol risks associated with each token market. Abnormal and unexpected price drops can be caused by a multitude of reasons ranging from infinite minting of tokens or coins, protocol rugs, or exploits of any sort. 

Collateral caps thus limit the maximum potential loss that the protocol would possibly suffer from a collapse or extreme price drops in the corresponding token markets, and are an effective way to control and manage risks. It is a critical feature that needs to be monitored and readjusted especially in volatile market conditions – as improper management can impact the lending and borrowing protocols and the ecosystems they are linked to in a chain effect.

Author Bio
Puff is a Contributor at Iron Bank. His experiences include founding and advising crypto projects, with a particular focus on cloud computing, DeFi and Blockchain over the past decade. With extensive leadership experience across various technology companies, Puff is passionate about driving innovation to maximize utility, adoption and security.
Iron Bank is a decentralized lending platform focused on capital efficiency allowing protocols and individuals to supply and borrow cryptocurrencies on Ethereum, Fantom, and Avalanche. It is helping build a better and safer DeFi lending ecosystem, by driving capital efficiency with trusted entities as the liquidity infrastructure and backbone for DeFi and CeFi. 
Iron bank harnesses smart contract automation to offer protocol-to-protocol lending via whitelisting with undercollateralized and uncollateralized lending. Partners include Fixed Forex (Keep3r Network), Yearn Vaults (Yearn Finance), Alpha Homora (Alpha Venture DAO), Multichain, PleasrDAO, and more. While it targets protocol use, non-protocol users can also supply and borrow on the Iron Bank. For more information, visit