Collateralization Ratio Constraints

Collateralization Ratio Constraints are security parameters set by lending protocols to ensure that loans remain over-collateralized to protect the lender against price volatility. The ratio represents the value of the deposited collateral relative to the value of the borrowed asset.

If the value of the collateral falls below a specific threshold, the protocol triggers a liquidation process to recover the borrowed funds. These constraints are essential for managing counterparty risk in decentralized lending where borrower identity is unknown.

By requiring more collateral than the loan value, the protocol accounts for the high volatility of digital assets. These parameters are often adjusted via governance to adapt to changing market risk profiles.

They act as a critical defense against bad debt and protocol insolvency.