Overcollateralization
A requirement for borrowers to deposit collateral worth more than the loan amount to mitigate risk.
What is Overcollateralization?
Overcollateralization ensures that the value of collateral exceeds the borrowed amount, typically by 150–200%, to protect lenders against price volatility in digital assets. For example, borrowing $1,000 USDC on Compound might require $1,600 in ETH at a 62.5% LTV ratio. If collateral value falls, automated liquidations repay the loan, maintaining protocol solvency. Introduced by MakerDAO in 2017, this mechanism is foundational to DeFi lending.
In 2025, average overcollateralization ratios across protocols like Aave and MakerDAO hover around 160%, balancing accessibility and security. Advanced protocols now support dynamic collateral requirements, adjusting based on asset volatility. For instance, during 2024’s market dip, overcollateralized loans prevented systemic losses, with $2 billion in collateral liquidated efficiently across major platforms.
Related Terms
Reserve Factor (Lending)
A percentage of interest retained by a lending protocol to fund operations or cover losses.
Liquidity Fragmentation
The dispersion of liquidity across multiple pools, chains, or exchanges, leading to inefficient pricing and higher costs.
SWIFT
Global financial messaging network integrating blockchain in 2025 to support stablecoin transactions and tokenized assets.
Market Order
An order to buy or sell an asset immediately at the best available current price.
Liquid Staking
A staking mechanism on Ethereum where users receive derivative tokens representing their staked ETH, allowing them to use these tokens in DeFi activities while earning staking rewards.
Non-convertible Preferred Stock
Preferred stock without conversion rights, focusing on fixed dividends and seniority.