Understanding Market Solvency Risk

The process involves evaluating and managing the risks associated with the solvency of markets, particularly focusing on the potential volatility of collateral assets such as meme coins. These assets may be subject to extreme conditions like liquidity collapse or coordinated selling, which could affect the ability to liquidate them quickly enough to cover outstanding debts.

Step 1

Assess market solvency risk by examining the volatility or thin trading of collateral assets, often referred to as meme coins. In extreme circumstances, such as rug pulls, liquidity collapse, or coordinated selling, there may be an inability to liquidate the collateral quickly enough to cover outstanding debt obligations.

Step 2

In the event of such a situation, the pool could encounter bad debt, where the value of outstanding loans surpasses the available collateral. This bad debt is confined to the affected market and is distributed across liquidity providers within the pool, minimizing individual losses without eliminating them entirely. This approach is intended to protect any single lender from a complete loss, although a partial reduction in their returns may still occur.