Over-Collateralization in Crypto: Extra Security for Loans

Over-Collateralization (OC) is the provision of collateral with a value greater than sufficient to cover potential losses in the event of default.

What is Over-Collateralization?

Recollateralisation is the granting of collateral whose value exceeds the amount sufficient to cover potential losses in the event of default. It is used for effective risk management and involves lending an asset as collateral when the value of the asset exceeds the value of the loan.

Stablecoins with overcollateralisation have a large number of cryptocurrency tokens that are held as a reserve for the issuance of fewer stablecoins. This creates a buffer against price fluctuations.

DAI, for example, uses a credit and redemption process using a secured debt position through MakerDAO to secure assets as collateral on the chain. Users can deposit Ether or other accepted cryptocurrencies and take credit against the value of their deposits to then receive newly created DAIs.

Securing Stablecoins, as demand and acceptance grows, is not always effective, as it means that collateral sitting idle can be used more effectively elsewhere. We are now seeing new innovations where Stablecoins, using algorithmic controllers, can issue more coins when the price rises and redeem them from the market when the price falls. This algorithmic manipulation of supply to change the price eliminates the need for collateral.