What Is “Over-Collateralization” and Why Is It Common in DeFi Options?
Over-collateralization means the value of the collateral locked in the smart contract is significantly greater than the value of the loan or the derivative exposure. It is common because DeFi lacks the legal recourse of traditional finance.
The extra collateral acts as a safety buffer against volatile price swings and ensures the debt can be covered even with rapid market drops. It reduces the risk of bad debt for the protocol.
Glossar
Legal Recourse
Remedy ⎊ Providing a means for investors to seek compensation for losses caused by fraud or negligence is essential for maintaining trust in the financial system.
Collateralization Ratio
MarginRequirement ⎊ The Collateralization Ratio quantifies the amount of posted margin relative to the notional value or exposure of a leveraged position, serving as the primary metric for assessing margin adequacy.