Supply Cap

A supply cap limits how much of one collateral asset a lending market accepts in total. Once deposits reach the cap, further supplies of that asset revert.

The cap exists because a collateral's price only holds for amounts the market can absorb. A token with a few million dollars of exchange liquidity cannot back a hundred million dollars of loans: if those loans go bad, liquidators can't sell the collateral for anything close to its quoted value, and the difference becomes bad debt.

Sizing it

Size a supply cap from exit liquidity, not from price: how much of the token could be sold into the deepest available markets, during stress, without moving the price beyond what liquidations can bear. Revisit it as that liquidity changes.

What it does and doesn't fix

A supply cap does not stop a price from being manipulated. It limits how much a manipulated or wrong price can cost. A thin token that can be pumped and looped is far less dangerous when the market will only ever hold a bounded amount of it.

Because raising a cap raises the market's exposure, cap increases are commonly placed behind a timelock so depositors can see them coming.