Definition ∞ Collateral inflation refers to an increase in the perceived value of assets used as collateral, often without a corresponding increase in fundamental worth. This phenomenon can occur in decentralized finance when volatile assets are overvalued as security for loans. It creates an elevated risk of liquidations if the collateral’s market price declines sharply. Such inflation can lead to systemic instability within lending protocols.
Context ∞ Concerns about collateral inflation are prominent during periods of speculative market activity, especially with newer, less established digital assets. Debates focus on appropriate collateralization ratios and the need for more stable collateral types. Monitoring the valuation of collateral assets is crucial for assessing protocol health.
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