Overcollateralization
The practice of depositing collateral worth more than the value of a loan to provide a safety buffer against price volatility. In DeFi, most lending protocols require overcollateralization because there is no credit scoring — the excess collateral protects lenders if the borrower's collateral loses value. Typical ratios range from 110% to 200%+.
“MakerDAO requires a minimum 150% collateralization ratio. To mint $10,000 of DAI, you must deposit at least $15,000 worth of ETH. If ETH's value drops below that ratio, your vault is liquidated.”
Collateral
Cryptocurrency assets pledged as security for a loan in DeFi protocols. Borrowers deposit collateral that exceeds the loan value (overcollateralization) to protect lenders from default risk. If the collateral's value falls below a certain threshold relative to the loan, it can be automatically liquidated.
Liquidation
The forced closing of a leveraged position or the seizure and sale of collateral when a borrower's position falls below the required margin or collateralization ratio. In DeFi lending, liquidation occurs automatically via smart contracts when the value of collateral drops below a protocol-defined threshold, protecting lenders from bad debt.
Lending Protocol
A DeFi protocol that enables users to lend crypto assets to earn interest or borrow assets against deposited collateral, all managed by smart contracts without traditional banks. Interest rates are typically set algorithmically based on the utilization rate (ratio of borrowed to supplied assets) within each lending pool.
DAI
A decentralized, crypto-collateralized stablecoin pegged to the US dollar, created by the MakerDAO protocol. Unlike USDC or USDT, DAI is not backed by fiat reserves — it is minted by users who deposit cryptocurrency as overcollateralized collateral into Maker vaults. DAI maintains its peg through algorithmic interest rates and liquidation mechanisms.