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Tag: crypto collateral

  • Day 22 — What Happens When a DeFi Loan Becomes Unsafe?

    Watercolor illustration of a DeFi loan health meter triggering collateral liquidation

    A DeFi loan begins with more collateral value than debt, but crypto prices can move quickly. If the collateral falls far enough, the protocol cannot wait for a human conversation or a monthly payment. Its smart contracts enforce a liquidation rule.

    Each market defines a threshold that determines how much borrowing a particular asset can support. Interfaces may summarise the buffer as a health factor. A comfortable value means the collateral can absorb some decline; a value near the limit means even a small price move may make the position eligible for liquidation.

    When the threshold is crossed, an independent liquidator can repay part of the borrower’s debt and receive some collateral, usually with a bonus. That reward motivates bots to act quickly. The protocol reduces risky debt, lenders remain better protected, and the borrower loses collateral plus a penalty.

    Consider ether collateral worth $1,500 against an $800 loan. If ether falls and the permitted borrowing limit drops below the debt, liquidation can begin. Adding collateral or repaying part of the loan before that point restores the safety margin. Watching only the original deposit price is not enough because the relevant values update continuously.

    Liquidation depends heavily on price oracles. A delayed or manipulated price can liquidate healthy users or leave the protocol with bad debt. Network congestion also matters: when many positions fail together, gas costs rise and liquidators may struggle to process them quickly.

    Borrowers can reduce risk by using less leverage, choosing strong collateral, maintaining a wide buffer, monitoring alerts, and understanding the exact threshold and penalty. There is no universal safe ratio because volatility, oracle design, and protocol rules differ.

    Liquidations show that attractive borrowing and lending rates come from a system of incentives and risk controls. Tomorrow we will ask the broader question behind every advertised return: where does crypto yield actually come from?

  • Day 17 — What Keeps a Stablecoin Stable?

    Watercolor illustration of a stablecoin balancing different forms of collateral around a price peg

    Bitcoin and ether can change price sharply within a day. That volatility makes them difficult to use as a unit of account or short-term parking place. Stablecoins attempt to solve this by targeting a steady reference price, most commonly one US dollar.

    The word stable describes a goal, not a guarantee. A stablecoin needs a mechanism that encourages its market price to return to the peg. The mechanism differs by design, and understanding it is more useful than trusting the name printed on the token.

    Fiat-backed stablecoins are issued against assets held by a company or custodian. In the ideal case, one token can be redeemed for one dollar, and traders buy or sell when the market price drifts. Users depend on the issuer, its banks, the quality of reserves, redemption rules, and the accuracy of public reports.

    Crypto-collateralised stablecoins use assets locked in smart contracts. Because crypto prices move, these systems normally require collateral worth more than the stablecoins created. If collateral falls too far, it can be liquidated to protect the system. This design is transparent on-chain but still exposed to market, oracle, and contract risks.

    Algorithmic designs try to manage supply using incentives or a related token, sometimes with little dependable collateral. They can appear efficient during calm markets, yet confidence can unravel quickly. If everyone wants to exit at once and the promised redemption value is not available, the feedback loop can break the peg.

    Stablecoins also differ in censorship controls, chain support, liquidity, legal claims, and technical bridges. Two tokens both trading near one dollar can therefore carry very different risks. It is worth checking the issuer, reserves, redemption path, contract permissions, and the network version you actually hold.

    Stablecoins became a basic building block for on-chain trading, borrowing, and payments. Tomorrow we will explore the larger system built from these pieces: decentralised finance, usually shortened to DeFi.