📈How does Ratio's Collateralization work?

Learn how we define and calculate the value of deposited LP.

Ratio is a platform where users can lock LP tokens as collateral in Ratio Vaults and, in exchange, may mint USDr tokens. Since lending and borrowing on Ratio lacks compulsory means on default, the system is always over-collateralized, which means that the dollar value of the locked collateral exceeds the dollar value of the issued USDr.

In practice the Loan to Value, aka the amount of USDr that can be minted, depends on two things: the Collateralization Ratio, defined by the protocol, and the LP token price, defined by the market. The functional form is

So it is important to do a deep dive into these two important features.

Collateralization Ratio

In our whitepaper we have quantified the LP risk as a combination of multiple correlated risky assets in a portfolio, as such, an LP token would be considered as a multi-asset portfolio characterized by the value invested in each asset.

For every Ratio Vault, we define the Collateralization Ratio as a function of the portfolio realized variance of the LP token such that

where λ is a parameter defined by the protocol and 𝜎 is the portfolio realized variance of the LP pool. We should note that CR is always greater than one to ensure an overcollateralized loan.

LP Pricing

Another important aspect to take into account is the price of the LP token that the user has minted. The market value of LP tokens is calculated by adding the total liquidity in the pool and dividing by the number of LP tokens issued,

Note that each protocol may use a different approach to price the LP token as they want however, the underlying reserves and prices of the individual constituents of an LP token are vulnerable to manipulations (e.g. Warp Finance’s exploit in December 2020) so by using a naive approach to LP pricing, Ratio would be vulnerable to flash loan attacks.

As we can see, the amount of USDr that may be minted by the user depends on a lot of factors. This allows for a rich variety of features that the user can track in order to maximize their leverage and track their portfolio. From Ratio’s perspective these are tools that help us guard our protocol from different attack vectors.