Normally, if assets are being borrowed, collateral is required to cover the loan. This collateral acts as your loan insurance. What’s its relevance? This is largely dependent on the protocol you’re funding; however, you may need to closely watch your ratio of collateralization.
If the value of your collateral goes below the protocol’s required threshold, this may result in the liquidating of your collateral in the open market. Is there anything you can do to prevent liquidation? You can increase your collateral.
To recap, the rules for this (i.e., the ratio of collateralization required) will be different for each platform. They also commonly function alongside a concept known as overcollateralization.
This simply means that in order to borrow, borrowers would need to deposit more value. This is done so to reduce the likelihood of aggressive market crashes liquidating huge collateral in the system.
Let’s assume your preferred lending protocol requires a 200% ratio of collateralization. What this means is that for every invested value of 100 USD, your maximum borrow amount will be 50 USD.
It is however safer to increase the collateral higher than is required in order to lower the risk of liquidation even further. That said, collateralization ratios as high as 750% would be used by many systems to protect the platform against the risks of liquidation.
