What Is the Difference between Under-Collateralized and Over-Collateralized Loans?
Over-collateralized loans require the borrower to deposit collateral with a value greater than the loan amount, common in DeFi due to the lack of identity verification. Under-collateralized loans require collateral less than the loan amount, or none at all, relying on credit history or reputation, common in traditional finance.
Flash loans in DeFi are a unique exception to over-collateralization.
Glossar
Under-Collateralized Loans
Definition ⎊ Under-collateralized loans are financial instruments where the value of the collateral provided by the borrower is less than the value of the loan amount.
Flash Loans
Mechanism ⎊ Flash loans represent uncollateralized lending protocols within decentralized finance, enabling users to borrow and repay funds within the same transaction block; this functionality is predicated on the deterministic nature of blockchain execution, eliminating credit risk for lenders.