What Is the Role of Over-Collateralization in Securing a Synthetic Asset?
Over-collateralization is a security mechanism where the value of the collateral locked in the smart contract is significantly greater than the value of the synthetic asset issued. For example, $150 of ETH might be locked to mint $100 of a synthetic asset.
This buffer protects the system against price volatility in the collateral asset. If the collateral’s price drops, the system has a margin of safety before the synthetic asset becomes under-backed, ensuring the asset maintains its price peg.
Glossar
Liquidation Mechanisms
Trigger ⎊ Liquidation mechanisms are automated processes in decentralized finance protocols designed to manage collateral risk in lending and derivatives markets.
Margin of Safety
Calibration ⎊ Margin of Safety, within cryptocurrency derivatives, represents a quantitative assessment of potential downside risk relative to anticipated return, functioning as a buffer against model inaccuracies and unforeseen market events.
Synthetic Asset
Derivation ⎊ Synthetic assets, within cryptocurrency markets, represent tokenized representations of other assets ⎊ equities, commodities, or even other cryptocurrencies ⎊ created through the use of smart contracts and collateralization mechanisms.