Collateralization Chains

Collateralization chains describe the interconnected structure where assets are used as collateral across multiple protocols to gain leverage or yield. This practice creates a complex web of dependencies, where the failure of one asset or protocol can have a domino effect on others.

For example, a user might deposit an asset into a lending protocol, receive a receipt token, and then use that token as collateral in another protocol to borrow more funds. While this increases capital efficiency, it also significantly raises systemic risk, as the health of the entire chain depends on the value and liquidity of the underlying assets.

Understanding these chains is vital for risk assessment, as it reveals the true extent of exposure to specific assets and the potential for contagion. It highlights the importance of transparent collateral management and the need for rigorous stress testing in DeFi.