What is collateral in crypto lending?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 4 min
In short
Collateral is the asset you lock up in advance so the lender has something to seize if the loan is not repaid. In DeFi it replaces credit checks entirely, which means that when the collateral falls in value it is sold automatically — whether or not you are watching.
Key points
- Assets pledged so the lender can recover an unpaid loan
- In DeFi it substitutes for any credit assessment
- A fall in its value triggers automatic sale
- Each protocol allows only a specific list of assets
Definition
Assets pledged to secure a loan. In DeFi they are locked in a smart contract and sold according to the contract's rules if the position is judged unable to repay.
A bank loan rests on income and credit history, with collateral as a backstop. DeFi knows neither your identity nor your repayment record, so collateral carries the entire relationship — and you generally cannot borrow more than what you have locked. Posting ETH to borrow stablecoins is the standard shape of it.
Each protocol maintains its own list of acceptable collateral. Thinly traded tokens are excluded, or allowed only at a low borrowing ratio, because there may be no bid when the protocol needs to sell. Even ETH derivatives such as liquid staking tokens usually get stricter terms, since their price can drift from ETH itself.
Once collateral is posted, every price move changes the ratio between what it is worth and what you owe. Cross the protocol's threshold and anyone can trigger a liquidation that sells part or all of the collateral at a discount. There is no warning and no grace period, which is why an unattended borrow is among the fastest ways to lose funds in DeFi.
Watch out for
- · Pledged assets cannot be sold or moved until the loan is closed
- · The ratio worsens not only when collateral falls but also when the borrowed asset rises
- · With centralised lending, deposits sit on the operator's balance sheet and may not come back if it fails