Risk Parameter
Any of the configurable settings a DeFi protocol's governance uses to control exposure to a given asset, such as its debt ceiling, liquidation threshold, or collateral factor.
A risk parameter is any configurable setting a DeFi protocol uses to control and manage its exposure to a given asset or market — common examples include a collateral factor (see Kaavon's "Collateral Factor" glossary definition), a liquidation threshold (see Kaavon's "Liquidation Threshold" glossary definition), a debt ceiling (see Kaavon's "Debt Ceiling" glossary definition), and an interest rate model's (see Kaavon's "Interest Rate Model" glossary definition) specific coefficients. These settings are typically adjustable through the protocol's governance process, rather than being permanently fixed at deployment.
Setting risk parameters appropriately for each supported asset requires balancing capital efficiency against safety: looser risk parameters (a higher collateral factor, a higher debt ceiling) let the protocol serve more borrowing demand against a given asset, but increase the protocol's potential losses if that asset's price moves sharply or its liquidity dries up. Risk parameters are commonly set more conservatively for newer, more volatile, or less liquid assets, and loosened gradually over time as an asset demonstrates sustained liquidity and price stability.
Examples
- A lending protocol's governance might vote to raise a specific asset's risk parameters, such as its debt ceiling, after that asset demonstrates months of stable liquidity and trading volume.
- Setting overly loose risk parameters on a volatile, thinly traded asset can expose a lending protocol to significant losses if that asset's price suddenly collapses.