// GLOSSARY -- DEFI

What is Collateral?

1 min read Updated

Collateral in DeFi is cryptocurrency deposited as security for a loan — if the borrower fails to maintain sufficient collateral value, the position is automatically liquidated to repay lenders.

WHY IT MATTERS

Collateral is DeFi's trust replacement. Traditional lending uses credit scores and legal enforcement. DeFi lending uses overcollateralization and automatic liquidation — the smart contract ensures lenders are always covered.

Different assets have different collateral factors based on volatility and liquidity. ETH might allow 80% LTV; a volatile altcoin might only allow 50%. Stablecoins as collateral often allow the highest LTV.

Collateral management is critical for borrowers: monitoring collateral ratios, adding collateral during drawdowns, and understanding liquidation thresholds prevents costly liquidation events.

FREQUENTLY ASKED QUESTIONS

What makes good collateral?
High liquidity (easily sold during liquidation), low volatility (stable collateral ratio), and deep markets. ETH and BTC are premium collateral; long-tail tokens are riskier.
What is the collateral factor?
The percentage of collateral value you can borrow against. An 80% factor means $1000 in collateral lets you borrow up to $800. Different assets have different factors based on risk.
Can I use LP tokens as collateral?
Some protocols accept LP tokens (Aave accepts some). This enables leveraged liquidity provision — but adds complexity and risk from impermanent loss on top of liquidation risk.

FURTHER READING

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