LLTV

Setting LLTV to Minimize Bad Debt

LLTV is calibrated with the objective of minimizing bad debt risk, based primarily on the asset’s price dynamics and the reliability of its liquidation pathways. The goal is to ensure that positions can be liquidated efficiently before reaching a state where collateral is no longer sufficient to cover outstanding debt.

Bad debt occurs when the Loan-to-Value (LTV) of a position exceeds the threshold defined by 1 / LIF. At this point, even if the full collateral is liquidated, the proceeds are insufficient to fully repay the borrowed amount, leaving residual debt in the system. To prevent this, LLTV is set with a deliberate buffer below this critical threshold, creating a margin of safety that allows liquidators to act before insolvency becomes possible.

Determining this buffer requires a detailed understanding of both the liquidation ecosystem and the asset’s price behavior. On the liquidation side, we assess how quickly and reliably liquidators can respond, including competition, infrastructure, and access to liquidity. On the pricing side, we analyze historical volatility, drawdowns, and short-term price shocks over conservative time windows to estimate how far prices could move between liquidation triggers and execution.

This ensures that even under stressed conditions—such as delayed liquidations, rapid price declines, or temporary liquidity constraints—there remains sufficient collateral value to fully cover the debt. The buffer is therefore not static, but tailored to the responsiveness of the market and the risk profile of the asset.

Supply Cap Impact

It is also important to note that LLTV is inherently a two-dimensional parameter. While higher LLTVs increase capital efficiency by allowing more borrowing, they simultaneously reduce the maximum safe supply cap for a market. This is because tighter margins based on LIF leave less room for price movement before reaching the bad debt threshold. As a result, LLTV directly impacts how much capital can be allocated, and must be optimized in conjunction with market caps to balance efficiency and safety.