Collateral
Collateral is an asset pledged to support a loan, derivatives position, stablecoin, or another financial obligation. If the required collateral value falls too far, it may be sold or liquidated according to the system's rules.
✦ Key Insight
Collateral is fundamental to crypto lending and leveraged trading. Because many DeFi loans do not rely on traditional credit checks, protocols often depend heavily on collateral to protect lenders.
✕ Common Misconceptions
Borrowing the maximum amount available
Ignoring volatility
Failing to monitor liquidation levels
Using correlated collateral
Ignoring oracle risk
Assuming collateral remains under unrestricted user control
Detailed Explanation
How It Works
A borrower deposits an accepted asset.
The protocol determines how much can be borrowed based on the collateral's value and applicable risk parameters.
Price oracles monitor the asset.
If its value declines below the required threshold, liquidation mechanisms can sell part or all of the collateral.
FAQs
Can cryptocurrency be collateral?
Yes.
Can collateral be liquidated automatically?
Yes, particularly in DeFi.
In Practice
Dig Deeper
Margin
Margin is the collateral a trader provides to open and maintain a leveraged trading position. It is not the same as the total value of the position.
Liquidation
Liquidation occurs when a leveraged trading platform forcibly reduces or closes a position because the trader no longer has enough margin to satisfy the required maintenance margin.