Overcollateralization

You want to borrow $100. The lender says: put up $150 first. That's overcollateralization — the borrower carries the risk, not the lender.

It exists because crypto has no credit checks, no income verification, and no collections department. The collateral is the only protection the protocol has. If you walk away, the smart contract keeps your deposit.

How It Works

The ratio that matters is LTV — loan-to-value. If a protocol allows 66% LTV on ETH, you can borrow $66 for every $100 of ETH you deposit. Flip that around: you're posting 150% collateral to receive 100% in borrowed funds.

Protocols set a liquidation threshold — the LTV level at which your collateral gets sold to repay the loan. On Aave, ETH's liquidation threshold sits at 83% LTV. You don't get a warning call. The contract executes automatically when the math hits that line.

The buffer between your borrow amount and that threshold is your safety margin. Borrow conservatively — say, 40% LTV when the limit is 80% — and a 30% price drop doesn't touch you. Borrow at 75% LTV and a 10% drop puts you in liquidation territory.

Why It Matters

Overcollateralization shapes every decision you make as a borrower: how much you can take out, what you pay in interest, and how much volatility you can survive before the protocol liquidates your position.

It also explains why DeFi lending rates are often lower than unsecured consumer credit. The lender's risk is nearly zero — the collateral covers the loan before any default can occur. You're essentially paying for access to liquidity you already own.

What to Watch

The collateralization ratio at origination is not the ratio that gets you liquidated. Those are two different numbers, and confusing them is the most common mistake borrowers make. You might deposit at 200% collateral, feel safe, and then watch a market drop compress that ratio to 110% — right at the liquidation threshold — in hours.