Collateral

Collateral is the security behind a debt. In crypto, a borrower deposits assets such as ETH, bitcoin or stablecoins into a lending protocol, an exchange margin account or a smart contract, and can only borrow or trade up to a fraction of that deposit's value. The deposit stays locked until the debt is repaid.

Because crypto prices swing sharply, most on-chain loans are overcollateralized: the borrower must post more value than they take out. Protocols set a different maximum for each asset based on its liquidity and volatility, and some stablecoins, such as DAI, are themselves created by locking collateral in smart contracts.

If the collateral loses value and the position crosses the protocol's threshold, it is liquidated, often with a penalty. Using volatile or thinly traded tokens as collateral raises that risk, and attackers have exploited protocols that accepted collateral whose price could be manipulated.