How Does Over-Collateralization Mitigate Systemic Risk in DeFi?

Over-collateralization requires a borrower to post collateral worth more than the value of the loan or derivative obligation. This buffer ensures that even if the collateral asset's price drops significantly, the protocol has time to liquidate the position without incurring a loss.

This excess security prevents a cascading series of defaults across the protocol, thereby strengthening the entire DeFi ecosystem against sudden market shocks.