Collateralization is the act of securing a loan or other financial obligation with an asset, which can be claimed by the lender if the borrower fails to meet their commitments. In the realm of digital assets, this typically involves pledging cryptocurrencies or other tokens as security. This process mitigates risk for the lender by providing a recovery mechanism in case of default. It is a fundamental component of many decentralized lending platforms.
Context
This practice is essential to decentralized finance (DeFi) lending protocols, where collateralization ratios and the types of accepted assets are central to risk management discussions. The inherent volatility of digital assets often necessitates over-collateralization in many DeFi applications, a key consideration for protocol stability and user safety. News often reports on changes to these requirements or the liquidation of under-collateralized positions.
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