What Is the Main Risk Over-Collateralization Aims to Mitigate?
The main risk over-collateralization aims to mitigate is the sudden, severe drop in the value of the volatile cryptocurrency collateral. Since the stablecoin is backed by assets like Ether or Bitcoin, a rapid market crash could cause the collateral's value to fall below the value of the minted stablecoins.
Over-collateralization provides a necessary buffer to absorb these price shocks, ensuring the system remains solvent and the stablecoin maintains its peg, preventing a cascading liquidation event.
Glossar
Cascading Liquidation
Dynamic ⎊ Cascading liquidation describes a dangerous market dynamic where the forced closure of one leveraged position triggers a rapid sequence of further liquidations across other accounts, often due to insufficient margin or shared collateral.
Cryptocurrency Collateral
Solvency ⎊ The quality of cryptocurrency collateral is fundamentally tied to the perceived long-term solvency and security of the underlying asset's network.
Collateralization Ratio
Margin ⎊ The collateralization ratio, within cryptocurrency and derivatives, represents the proportion of collateral deposited relative to the value of the underlying asset or open position; it functions as a critical risk management parameter, directly influencing systemic stability and counterparty exposure.