It’s a problem because it doesn’t actually follow the size of the ship that is flying here and you can hit asteroids with your ship even though they are above or below you. How would I get around this type of collision?
If I could replace the capsule with a box I could make it fit much more closely but that’s not possible.
If the only thing you have to worry about is the collision with the asteroids, set the capsule & asteroids to ignore each others collision type.
Then, to make sure the ship can be hit, set the ships mesh & asteroids to use the same collision.
Depending on how good the physics assets for the meshes are, you may have to enable complex collision and/or continuous collision detection (CCD).
This is the same method used to make projectiles (e.g. bullets) accurate to a players mesh rather than the capsule used for movement.