Collateral
Collateral is an asset pledged by a borrower to secure a loan. In the event the borrower cannot repay, the lender can claim the collateral to cover the outstanding debt. In decentralized finance (DeFi), users often provide cryptocurrency as collateral to access loans or leverage their assets.
What is Collateral?
Collateral acts as security for the lender, ensuring they can recover losses if the borrower defaults. In crypto lending, collateral is usually provided in the form of digital assets, which remain locked until the loan is repaid.
How Does Collateral Work?
The collateralization process involves several steps:
Asset Deposit: The borrower deposits collateral (e.g., ETH or BTC) into a smart contract or lending platform.
Loan Issuance: Based on the collateral’s value, the borrower receives a loan in another asset or stablecoin.
Collateral Release: When the loan is repaid, the collateral is released to the borrower. If the borrower defaults, the lender may liquidate the collateral to cover the loan.
Why is Collateral Important?
Collateral is essential for several reasons:
Lender Protection: It reduces the risk for lenders, providing security if the borrower defaults.
Access to Liquidity: By using their crypto as collateral, borrowers can access funds without selling their assets.
DeFi Lending Model: Collateral is fundamental to DeFi lending, enabling decentralized, trustless loans without intermediaries.
In summary, collateral is a critical element in both traditional and DeFi lending, providing security for lenders and liquidity access for borrowers.