Overcollateralized Loans

Definition ∞ Overcollateralized loans require borrowers to deposit collateral exceeding the value of the borrowed digital assets. This mechanism is a fundamental component of many decentralized finance lending platforms, providing a safety margin for lenders against price volatility of the collateral. If the collateral value drops below a certain threshold, the loan can be liquidated automatically by smart contracts to protect the lender’s capital. It reduces counterparty risk in permissionless lending environments.
Context ∞ News often discusses the liquidation risks associated with overcollateralized loans during periods of high market volatility, affecting both borrowers and protocol stability. A key debate involves optimizing collateral ratios and liquidation thresholds to balance borrower access with lender security. Future innovations may include dynamic collateral management and more sophisticated risk assessment models.