Undercollateralized lending involves providing loans where the value of the collateral pledged by the borrower is less than the loan amount. This type of lending carries higher risk for the lender, relying more on the borrower’s creditworthiness or reputation rather than asset-backed security. It contrasts with traditional collateralized loans that demand excess collateral.
Context
In decentralized finance, undercollateralized lending is a significant area of innovation and risk. News reports frequently discuss new protocols attempting to facilitate such loans, often leveraging credit scores built on blockchain data or reputation systems. This development seeks to expand access to capital beyond the overcollateralized models prevalent in early DeFi, albeit introducing more complex risk management challenges for lenders and protocols.
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