How Does the Concept of “Protocol Insolvency” Relate to the Valuation of Its Native Token?

Protocol insolvency occurs when a protocol's liabilities (e.g. user deposits, debt) exceed its assets (e.g. collateral, treasury funds). This event severely damages the protocol's reputation and can lead to a complete loss of confidence, causing the native token's value to plummet to near zero.

The risk of insolvency must be factored into the discount rate; a higher perceived risk of insolvency leads to a lower intrinsic valuation.