Over-Collateralization

Definition ∞ Over-collateralization is the practice of providing more collateral than the value of the loan or debt received. In decentralized finance (DeFi), this mechanism is commonly employed to secure loans of volatile digital assets, ensuring that even if the collateral’s value drops, there remains sufficient backing for the borrowed amount. For instance, a user might deposit $150 worth of Ether to borrow $100 worth of a stablecoin. This surplus collateral acts as a buffer against market fluctuations and minimizes default risk for lenders.
Context ∞ The state of over-collateralization is a fundamental aspect of risk management within many DeFi lending protocols. The discussion centers on maintaining solvency and stability in volatile digital asset markets. News often highlights liquidation events when collateral values fall below predefined thresholds. A key debate involves the optimal collateralization ratios and the trade-off between capital efficiency for borrowers and security for lenders. Future developments will involve dynamic collateral requirements and advanced risk models to adapt to changing market conditions.