Collateral Rehypothecation Risk

Collateral rehypothecation risk arises when the same collateral is pledged across multiple protocols or derivative contracts. In the digital asset space, users often deposit tokens into a lending protocol and use the resulting receipt tokens as collateral elsewhere.

If the underlying asset experiences a sudden price drop, the entire chain of rehypothecated positions faces simultaneous liquidation risk. This creates a hidden layer of leverage that is difficult to track on-chain.

If one protocol fails, the contagion spreads to every other protocol that accepted the rehypothecated asset. This risk is a significant concern for the stability of decentralized finance ecosystems.

It underscores the importance of transparency in collateral reuse.