Bad Debt Mitigation Strategies

Bad debt mitigation strategies are the defensive measures implemented by a protocol to handle situations where the value of collateral is insufficient to cover the liabilities of an insolvent account. These strategies include insurance funds, socialized losses, or minting new tokens to recapitalize the protocol.

Each approach carries different trade-offs regarding risk distribution and incentive alignment among participants. In the derivatives space, minimizing bad debt is essential for maintaining user trust and the long-term viability of the platform.

By proactively designing these strategies, protocols can absorb shocks without collapsing. This field analyzes the effectiveness of various models in different market environments, providing a blueprint for sustainable decentralized finance design.