Protocol Insolvency Risk

Definition ∞ Protocol insolvency risk is the potential for a decentralized finance (DeFi) protocol to become unable to meet its financial obligations to users or other protocols, often due to insufficient collateral, smart contract exploits, or severe market downturns. This risk indicates a failure in the protocol’s economic design or operational security. It can result in significant losses for participants and erode trust.
Context ∞ Protocol insolvency risk is a critical concern in the rapidly evolving DeFi sector, particularly for lending platforms and stablecoin mechanisms that rely on overcollateralization or algorithmic stability. Robust risk management frameworks, transparent auditing, and stress testing are essential to mitigate this risk. News frequently covers instances of protocols facing or succumbing to insolvency, highlighting the fragility and systemic risks within the DeFi ecosystem.