DeFi Contagion

DeFi contagion describes the process by which a failure or liquidity crisis in one decentralized finance protocol spreads to other protocols due to their high level of integration. Because many DeFi applications rely on the same liquidity pools, collateral types, and price oracles, they are deeply interconnected.

If a major protocol is hacked or suffers a severe liquidation event, it can impact the solvency of other protocols that hold its tokens as collateral. This creates a systemic risk where the entire ecosystem becomes vulnerable to the failure of a single component.

Understanding DeFi contagion is critical for assessing the stability of the broader decentralized financial system. It emphasizes the risks associated with the composability and interconnected nature of blockchain-based financial applications.