Collateral is an asset deposited by a user to secure a loan or another financial position in a DeFi protocol. It protects the lending system because the protocol can liquidate part of the collateral if the borrower no longer provides sufficient security for the outstanding debt.

In decentralized lending, collateral is usually locked in a smart contract. The user does not transfer it to a bank employee or centralized lender. Instead, the contract controls the asset according to the rules encoded in the protocol.

Most lending markets use overcollateralization. The value of the collateral must exceed the value of the debt, creating a buffer against market movements. The required buffer differs between assets and protocols.

The value of collateral must be continuously or periodically evaluated. A price oracle commonly supplies the market price. If the collateral declines relative to the debt, the position becomes increasingly risky.

When a position reaches the protocol liquidation threshold, liquidators may be able to repay debt and receive a portion of the collateral according to the protocol rules.

Collateral can also be used in complex composable strategies. An asset can serve as collateral in one protocol while borrowed assets are deployed elsewhere. This increases capital efficiency but also creates interconnected risks across several protocols.