Collateral

Collateral is an asset a borrower pledges to secure a loan. If the borrower does not repay, the lender has the right to claim the pledged asset to recover what it is owed. This lowers the lender's risk and is a common feature of secured borrowing.

In traditional finance, collateral is often a house backing a mortgage or a car backing an auto loan. The loan is tied to that specific asset, and the lender can take possession of it if payments stop.

In on-chain lending, collateral is a crypto asset locked in a smart contract while a loan is open. Borrowers usually post collateral worth more than they borrow, a practice called overcollateralization. If the value of the collateral falls below a set threshold, the position can be liquidated, meaning the collateral is sold to repay the loan.