Collateralized Risk

Definition ∞ Collateralized risk refers to the potential loss associated with an asset used as security for a loan or financial position. This risk arises when the value of the collateral asset decreases, potentially falling below the outstanding loan amount, or when the collateral itself becomes illiquid or otherwise compromised. Lenders face exposure if the borrower defaults and the seized collateral does not cover the debt. Borrowers confront liquidation risk if their collateral value drops significantly, triggering margin calls or automatic sales.
Context ∞ In decentralized finance (DeFi), collateralized risk is a central theme, particularly with lending protocols and stablecoins backed by volatile crypto assets. News often reports on liquidations during market downturns, where collateral values fall rapidly, leading to forced sales. A critical aspect involves the design of overcollateralization ratios and liquidation mechanisms to manage this exposure within smart contracts.