What Is “Over-Collateralization” and Why Is It Common in DeFi?

Over-collateralization is the practice of requiring a borrower to post collateral worth more than the value of the loan or derivative position they are taking. It is common in DeFi because there is no central legal system or credit check to enforce repayment.

The excess collateral acts as a safety buffer against the volatility of the crypto assets, ensuring that the lender or counterparty can be fully repaid even if the collateral's value drops significantly.