Bad Debt Write-Offs

Bad Debt Write-offs occur when a protocol cannot recover the full value of a loan, leaving a deficit that must be covered. This happens when collateral value drops so fast that the liquidation mechanism fails to sell it for enough to cover the debt.

To handle this, protocols may use reserve funds, insurance modules, or socialized losses where all depositors share the burden. Writing off bad debt is a final resort to restore the protocol's balance sheet.

It is a negative event that impacts user trust and protocol value. Managing the risk of bad debt is the primary goal of collateral factor tuning and liquidation engine design.

It represents the ultimate failure of the protocol's risk management parameters.