Overcollateralization

Definition ∞ Overcollateralization is the practice of requiring collateral with a value exceeding the amount of the loan or debt secured. This additional collateral serves as an extra layer of protection for the lender against potential default or asset price depreciation. It reduces the lender’s risk exposure, particularly in volatile markets, by providing a buffer against adverse market movements.
Context ∞ Overcollateralization is a fundamental security mechanism in decentralized finance (DeFi) lending protocols. Given the pseudonymous nature of borrowers and the volatility of many crypto assets, protocols often demand collateral significantly greater than the loan amount to ensure repayment. This mechanism helps maintain the solvency of lending pools and protects lenders, although it also means borrowers must lock up more capital than they receive, affecting capital efficiency.