Collateral Hierarchy

Collateral hierarchy is the systematic classification of different assets based on their liquidity, volatility, and risk profile for the purpose of backing loans or derivative positions. Protocols often assign different loan-to-value ratios to assets based on this hierarchy, requiring more collateral for volatile or illiquid tokens and less for stablecoins or blue-chip assets.

This structure ensures that the protocol's overall risk exposure is mitigated by favoring higher-quality assets. During market stress, the hierarchy may be adjusted, with certain assets being downgraded or removed from the list of accepted collateral.

It acts as a defense mechanism, preventing the protocol from becoming over-reliant on assets that may lose value rapidly. The hierarchy is dynamic and often governed by decentralized autonomous organizations to respond to changing market conditions.

It provides a foundational layer of security for the entire lending ecosystem.