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Over-collateralization Meaning

A lending risk management method where the borrower must provide assets worth more than the value of the loan. This is standard in DeFi.

To borrow $100 of DAI (stablecoin) on MakerDAO, you might need to deposit $150 worth of ETH. This 150% collateralization ratio protects the lender.

If the price of ETH drops, the protocol can sell the collateral to repay the loan before the position becomes insolvent. This differs from traditional finance (fractional reserve), where banks lend out more than they have.

Over-collateralization makes DeFi robust but capital inefficient, as a lot of capital sits idle just to secure loans.

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