Collateral Tokens: Securing DeFi Transactions

Collateral Tokens are tokens that are used as an asset to reduce the risk of borrowing other types of cryptocurrency tokens.

What are Collateral Tokens?

As in traditional finance, collateralised tokens serve as an asset to mitigate risk for lenders when borrowers want a cryptocurrency loan. Collateral is usually an asset that can cover at least part of the loan that the borrower takes out. One of the most common forms of collateral is property. Let’s say you take out a mortgage to buy a new house – essentially, you’re offering the house as collateral in case you can’t make your mortgage payments.

In cryptocurrency, the collateral process is about the same as in traditional finance. You want to borrow cryptocurrency and the lender wants to reduce their risk - then they ask for collateral.

Communication between the lender and the borrower takes place on a blockchain – this has facilitated the emergence of collateral tokens. Borrowers deposit a certain amount of one token in order to receive a certain amount of another token.

Today, there are several collateral tokens. The lending platform determines the collateral token that the borrower must deposit. One of the most recognisable collateral tokens today is COLL (Collateral Pay). This token was created to be used as collateral, and it allows owners to pay for goods and services with fiat borrowed against their COLL.

As DeFi evolved, the need for a blockchain-based lending system emerged. Collateral tokens make the creation of such an ecosystem quite feasible. Traditional lenders have taken collateral as insurance for their investments, but this is not the case with cryptocurrencies. As the blockchain space has become more accessible and cryptocurrencies have gained popularity, the need for collateral lending has arisen.

Collateralised tokens solve the high risk problem faced by cryptocurrency lenders. By accepting a deposit in collateralised tokens, lenders are assured that they will receive a portion of the capital back if the loan is not repaid.

Collateral deposits vary depending on the type of loan and the collateral tokens required. As with COLL, crypto-enthusiasts use collateral tokens to pay for goods and services in fiat. This is very convenient for crypto investors as it gives them a versatile portfolio that can be used on a daily basis.

Collateral tokens are an important component of the cryptocurrency and blockchain ecosystem. Their foundation is built on traditional finance, but they build on that foundation to bring lending into the crypto ecosystem.