Glossary · O
Overcollateralisation
The requirement that the value of collateral deposited exceeds the value of the loan taken. DeFi lending protocols require overcollateralisation (typically 110–175%) to protect lenders in case of rapid collateral price declines. A borrower depositing $1,500 of ETH to borrow $1,000 of USDC has a 150% collateral ratio.
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How Overcollateralisation works in practice
Over-collateralisation means locking more value than you borrow. It exists because DeFi lending is anonymous and non-recourse: there is no identity to pursue and no court to appeal to, so the collateral has to be sufficient on its own, with a margin for the price falling before liquidation completes.
Worked example
Borrowing 1,000 USDC against ETH at a 150% collateralisation ratio requires 1,500 of ETH locked. The extra 500 absorbs price movement between the moment the collateral becomes insufficient and the moment a liquidator can act.
Figures are illustrative and chosen to be checkable, not live market data.
The mistake that costs people money
Expecting capital efficiency comparable to traditional credit. Locking 1,500 to borrow 1,000 is the cost of doing without identity and enforcement. Designs promising materially better ratios are usually relying on correlated collateral, which behaves well until it does not.
Overcollateralisation: common questions
- What is Overcollateralisation?
- The requirement that the value of collateral deposited exceeds the value of the loan taken. DeFi lending protocols require overcollateralisation (typically 110–175%) to protect lenders in case of rapid collateral price declines. A borrower depositing $1,500 of ETH to borrow $1,000 of USDC has a 150% collateral ratio.
- How does Overcollateralisation work in practice?
- Over-collateralisation means locking more value than you borrow. It exists because DeFi lending is anonymous and non-recourse: there is no identity to pursue and no court to appeal to, so the collateral has to be sufficient on its own, with a margin for the price falling before liquidation completes.
- Can you give an example of Overcollateralisation?
- Borrowing 1,000 USDC against ETH at a 150% collateralisation ratio requires 1,500 of ETH locked. The extra 500 absorbs price movement between the moment the collateral becomes insufficient and the moment a liquidator can act.
- What do people get wrong about Overcollateralisation?
- Expecting capital efficiency comparable to traditional credit. Locking 1,500 to borrow 1,000 is the cost of doing without identity and enforcement. Designs promising materially better ratios are usually relying on correlated collateral, which behaves well until it does not.