Bad Debt Absorption refers to the process by which a decentralized finance protocol or lending platform manages and covers unrecoverable loans. This mechanism typically involves utilizing a portion of protocol reserves, insurance funds, or community-contributed capital to offset losses. It aims to maintain the solvency and stability of the lending system when borrowers default on their collateralized positions. Effective absorption mechanisms are vital for the sustained operation of these financial systems.
Context
The crypto sector often focuses on bad debt absorption during periods of market downturn or extreme volatility, when liquidations may not fully cover outstanding loans. A key discussion point involves the sustainability and fairness of different absorption strategies. Future developments may include more robust algorithmic solutions and diversified reserve structures to enhance resilience.
A systemic design flaw permitting extreme leverage on low-liquidity assets enabled an attacker to inflict a $4.9M loss via calculated market manipulation.
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