Collateral

What Is Collateral in Crypto?

Collateral is an asset a borrower pledges to a lender as security against a loan. If the borrower fails to repay, the lender can seize and sell the collateral to recover their funds. In traditional finance, collateral typically takes the form of property, vehicles, or cash deposits. In crypto, it is usually a digital asset: most commonly Bitcoin or ether, though stablecoins and other tokens are also accepted on various platforms.

The principle is the same as in traditional lending, but the mechanics can differ significantly. Crypto collateral is deposited into a smart contract or held by a platform, locked until the loan is repaid. Due to the volatility of crypto assets, crypto loans are almost always overcollateralized, which means a borrower must deposit more value than they receive. This protects the lender against price swings in the collateral’s value.

How Does Collateral Work in Crypto?

The ratio between a loan’s value and the collateral backing it is called the loan-to-value ratio (LTV). If the collateral’s market value drops and the LTV rises toward the lender’s threshold, the borrower receives a margin call: add more collateral or face liquidation. Liquidation means the platform sells enough collateral to cover the outstanding debt, often automatically and without delay.

Collateral functions slightly differently depending on the type of platform you use. On a centralized lending platform, the borrower transfers the asset to the platform, which holds it in custody. On a decentralized protocol, the collateral is locked in a smart contract, governed by code rather than a centralized entity.