Why Is Over-Collateralization a Key Feature for Decentralized Stablecoins Used in Lending and Derivatives?

Over-collateralization is essential for decentralized stablecoins because their collateral is typically a volatile cryptocurrency, not fiat. Since the collateral value can drop suddenly, holding more collateral than the stablecoin value (e.g.

$150 of ETH for $100 of stablecoin) acts as a buffer. This buffer ensures that even if the collateral price drops, the system has time to liquidate the position before the stablecoin becomes under-collateralized, thus maintaining the peg and system solvency for derivatives and lending protocols.