# Collateralization

### What is Collateralization?

In the Electra Liquidity Provider Pool, collateralization refers to the relationship between the total assets in the pool and the total supply of ELPP tokens. This ratio is fundamental to understanding how value is tracked and distributed among liquidity providers.

#### Collateralization Ratio Formula

$$
\text{Collateralization Ratio} = \frac{\text{Total Assets}}{\text{Total ELPP Token Supply}}
$$

* **Total Assets**: The combined value of all assets in the pool.
* **Total ELPP Token Supply**: The total number of ELPP tokens issued to liquidity providers.
* **Ratio Value**: Represents **the value of 1 ELPP token** at any moment.

**Example**:

* If the pool holds **$1,000,000** in assets and has **500,000 ELPP tokens** in circulation:

$$
\text{Collateralization Ratio} = \frac{1,!000,!000}{500,!000} = 2 \ \text{(1 ELPP token = $2 of assets)}.
$$

This ratio represents the precise value of each ELPP token at any given time. As the pool generates profits or incurs losses, this ratio changes, directly reflecting the performance of the broker's trading activities.

* **Profits**: If the pool generates profits (e.g., from broker trading), **Total Assets** increase → **Collateralization Ratio rises** → each ELPP token becomes more valuable.
* **Losses**: If the pool incurs losses, **Total Assets** decrease → **Collateralization Ratio falls** → each ELPP token loses value.

***

### Core Principles of the Collateralization Mechanism <a href="#docs-internal-guid-dff68e64-7fff-2ef7-3ee3-a841a3097ce3" id="docs-internal-guid-dff68e64-7fff-2ef7-3ee3-a841a3097ce3"></a>

1. Preservation of Value: The collateralization ratio ensures that each ELPP token maintains its proportional claim on the pool's assets
2. Automatic Profit Distribution: As profits accumulate, the ratio increases, automatically distributing returns to all token holders
3. Proportional Loss Sharing: Any losses reduce the ratio, distributing losses proportionally among all token holders
4. Deposit/Withdrawal Neutrality: The ratio remains unchanged during deposits or withdrawals since both assets and tokens change proportionally

***

### How Collateralization Works&#x20;

Let's follow the pool's value over time to see how collateralization works. For simplicity we assume that there are no withdrawals made during the period.

#### Initial State

* Total Assets: 10,000 USD
* Total ELPP Supply: 10,000 tokens
* Collateralization Ratio: 10,000 ÷ 10,000 = 1.0

At this point, each ELPP token is worth exactly 1 USD.

#### After First Profit Period

* New Total Assets: 10,100 USD (reflecting an additional profit of 100 USD)
* Total ELPP Supply: Still 10,000 tokens (no new tokens minted for profits)
* New Collateralization Ratio: 10,100 ÷ 10,000 = 1.01

The system updates the collateralization ratio to 1.01, meaning each ELPP token is now worth 1.01 USD. Every token holder has automatically received their proportional share of the 100 USD profit through this increased token value.&#x20;

Even though no new tokens were distributed, every token holder has automatically received their share of the 100 USD profit through the increased token value. If you held 1,000 tokens (10% of the pool), your share of the profit would be 10 USD, reflected in your tokens now being worth 1,010 USD instead of 1,000 USD.

***

### Impact of Deposits and Withdrawals

One of the most important features of the ELPP system is that people joining or leaving the pool doesn't change the value of each token. This ensures complete fairness for all participants.

#### Deposit Example

When Alice deposits 1,000 USD when the collateralization ratio is 1.01:

* ELPP Tokens Received: 1,000 ÷ 1.01 ≈ 990.1 tokens
* New Total Assets: 10,100 + 1,000 = 11,100 USD
* New Total ELPP Supply: 10,000 + 990.1 = 10,990.1 tokens
* Collateralization Ratio: 11,100 ÷ 10,990.1 = 1.01 (unchanged)

Alice receives fewer tokens than the USD value she deposits because each token is already worth 1.01 USD due to previously accumulated profits.

#### Withdrawal Example

When Bob decides to withdraw 2,000 ELPP tokens when the collateralization ratio is 1.01:

* Assets Received: 2,000 × 1.01 = 2,020 USD
* New Total Assets: 11,100 - 2,020 = 9,080 USD
* New Total ELPP Supply: 10,990.1 - 2,000 = 8,990.1 tokens
* Collateralization Ratio: 9,080 ÷ 8,990.1 = 1.01 (unchanged)

Bob receives more USD than the number of tokens he's returning because his tokens have increased in value due to accumulated profits.

***

### When and How the Ratio Changes

The collateralization ratio is typically updated at specific intervals (e.g., at the end of each epoch or when profit/loss is realized) based on:

1. **Realized Profits:** When trading positions are closed with profit
2. **Realized Losses:** When trading positions are closed with loss
3. **Unrealized PNL** Adjustments: Periodically accounting for the estimated value of open positions

Between these updates, the ratio stays fixed. This means that if you deposit or withdraw during a stable period, you'll receive tokens or assets based on the same ratio as everyone else during that time.

***

### What This Means for You as a Liquidity Provider

When you provide liquidity to the ELPP:

1. You receive tokens worth exactly your deposit amount (initially)
2. As the pool generates profits, your tokens become more valuable
3. When you withdraw, you receive your original deposit plus your share of all accumulated profits (or minus your share of any losses)
4. The timing of your deposits and withdrawals doesn't affect the fairness of what you receive

In practical terms, the collateralization mechanism offers you these benefits:

* **Fair Profit Sharing:** You earn exactly your proportional share of all trading profits
* **No Dilution:** New depositors don't reduce your profit share
* **Transparent Value:** You can always calculate exactly what your tokens are worth
* **No Harvesting Needed:** Profits are automatically reflected in your token value
* **Flexibility:** Your ELPP tokens can be transferred or used in other protocols while maintaining their value

The collateralization ratio is what makes the ELPP system both powerful and fair, ensuring that all participants benefit from the pool's performance in direct proportion to their contribution.

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