Overcollateralization
Definition
Overcollateralization means locking up more value in collateral than the amount borrowed or minted. This buffer protects lenders and stablecoin holders against price drops in the collateral asset. For example, MakerDAO requires at least 150% collateral to mint DAI, meaning you need $150 of ETH to mint $100 of DAI. It's the foundation of most DeFi lending and decentralized stablecoins.
Example
To borrow 1000 LUSD on Liquity, you must deposit at least $1100 worth of ETH (110% minimum collateralization ratio), though most users maintain 150%+ for safety.
Risks to Consider
- Capital inefficiency
- Liquidation risk if collateral drops
- Opportunity cost of locked capital
Common Questions
Why not use 1:1 collateralization?
Crypto assets are volatile. If collateral drops in value to less than the loan, the protocol accumulates bad debt. Overcollateralization provides a buffer to liquidate positions before they become underwater.
