Collateral

What Is Collateral?

Collateral refers to assets that you temporarily provide as security to obtain a loan or guarantee the fulfillment of obligations. If you default or exceed risk limits, the lender or protocol has the right to liquidate these assets. The core function of collateral is to transform “credit” into asset-backed security.

In everyday life, a house serves as collateral for a mortgage. In Web3, users often use ETH or stablecoins as collateral to borrow other assets. To serve effectively as collateral, assets must be easy to value and liquidate; otherwise, forced liquidation may lead to losses.

What Role Does Collateral Play in Traditional Finance?

In traditional finance, collateral is a tool to reduce default risk. Banks use it to determine loan amounts and interest rates.

For example, in a mortgage, the house is the collateral; for auto loans, the vehicle serves as collateral; when increasing a credit line, deposits or bonds can also act as collateral. Banks set loan-to-value ratios based on the asset’s valuation and liquidity, and may require additional collateral or early repayment if the asset’s price declines.

How Does Collateral Work in Web3 and DeFi?

In Web3 lending protocols, collateral is typically a tradable token whose value is tracked in real time by a price oracle. When a risk threshold is reached, protective mechanisms are triggered.

A “price oracle” is a service that securely brings off-chain price data on-chain, enabling protocols to calculate your collateralization ratio and portfolio health. If the collateral price falls to the liquidation threshold, the system automatically sells part of your collateral to repay the debt—a process known as “liquidation”—to ensure the protocol remains solvent.

With platforms like Aave or MakerDAO, users lock collateral such as ETH into a smart contract and borrow funds or mint stablecoins according to specific parameters. The protocol continuously monitors asset prices and position health; if risk thresholds are breached, users are prompted to add more collateral or face automatic liquidation.

What Is Collateralization Ratio? Why Is Overcollateralization Common?

The collateralization ratio is the proportion of the loan amount relative to the value of your collateral. To mitigate price volatility, on-chain lending usually requires “overcollateralization,” meaning the loan amount is less than the value of the collateral.

For example, with blue-chip assets: As of H2 2025, mainstream DeFi lending protocols typically allow 70%–85% loan-to-value (LTV) ratios for ETH-class collateral, with specific parameters varying by protocol and risk profile. Liquidation thresholds are usually set slightly above LTV, and liquidation penalties often range from 5%–15% (based on public parameter pages and governance updates). Overcollateralization provides a buffer against market swings and reduces the likelihood of forced liquidation.

What Types of Collateral Are There? Which Are Most Common?

Collateral types are distinguished by how easily they can be valued and liquidated. The more “transparent” and “liquid” an asset is, the more suitable it is as collateral.

Common forms of collateral include:

• Leading crypto assets: ETH, WBTC, and stablecoins offer transparent pricing and deep liquidity, making them widely used.
• Liquid staking tokens (LST): These represent staked assets as tradable tokens, allowing both collateralization and partial yield retention—but introduce additional risks.
• RWA (Real World Assets): Tokenized government bonds or deposit certificates are increasingly used in some stablecoin and lending protocols but involve complex compliance and off-chain integration.
• NFT-based collateral: Available on specialized protocols but come with significant pricing and liquidity volatility, leading to higher risk.

How Do You Borrow Against Collateral in Lending Protocols?

You can use collateral to obtain liquidity from lending protocols by following these steps:

Step 1: Choose a protocol and asset. Prioritize high-market-cap, highly liquid assets such as ETH or major stablecoins. Review protocol risk parameters and fees.

Step 2: Deposit your collateral. Transfer tokens into the protocol’s collateral vault; the system will display your available borrowing limit, current collateralization ratio, and position health.

Step 3: Borrow assets. Select the asset type and amount to borrow within your borrowing limit. Leave a safety buffer—do not maximize your collateralization ratio.

Step 4: Monitor and manage. Set up price alerts; if markets decline, promptly add more collateral or partially repay to avoid liquidation and penalties.

Step 5: Repay and withdraw. After repaying principal and interest, withdraw your collateral. If you generated profit from borrowing, account for total costs and risk exposure.

How Can You Use Collateral for Borrowing and Leverage on Gate?

On Gate’s platform features, your spot assets can serve as collateral to boost capital efficiency or engage in leveraged trading.

For borrowing: Step 1: Prepare your collateral in your account (e.g., ETH or stablecoins), leaving room for transaction and network fees.

Step 2: Go to the borrowing page, select your collateral asset and desired borrowed asset. The system displays available borrowing limits, collateralization ratios, and risk levels.

Step 3: After confirming the loan, monitor your collateral value and position health; add more collateral or repay as needed.

For leverage/margin trading: Your assets act as margin—essentially serving as collateral. The liquidation threshold for your position functions as the liquidation threshold. Pay close attention to maintenance margin requirements and funding rates to avoid forced liquidation during periods of high volatility.

What Are the Risks of Collateral? How Can You Mitigate Them?

Key risks associated with collateral include price volatility, insufficient liquidity, oracle failures, slippage during liquidation, as well as platform compliance or technical risks.

Risk mitigation strategies:

• Choose highly liquid assets with relatively stable prices; avoid niche or hard-to-value assets.
• Maintain a sufficient buffer by keeping your collateralization ratio in a safe range; diversify collateral if necessary.
• Use price alerts and automated management tools to add or remove collateral proactively.
• Understand the protocol’s liquidation logic and penalty structure; review risk disclosures and parameter pages.
• Stay alert to platform risks—monitor custody methods, compliance information, and security audits.

Key Takeaways on Collateral

Collateral transforms credit needs into asset-backed security—a foundational concept in both traditional finance and Web3. On-chain, oracles and parameter systems dynamically manage collateral value. Overcollateralization is standard practice to mitigate volatility. Choosing highly liquid, transparently priced assets and maintaining conservative collateralization ratios—along with proactive position management—can improve capital efficiency while reducing the risk of liquidation and loss.

FAQ

What Is the Difference Between Collateral and Pledge?

Both involve using assets to secure loans, but there are key distinctions. With collateral (typically immovable property like real estate or vehicles), the borrower retains usage rights; with pledge (typically movable property or rights certificates), assets are handed over to the creditor and usage rights are lost. Simply put: with collateral you still use the asset; with pledge you give up control.

In DeFi Lending, What Happens If My Collateral Value Drops?

If your collateral price drops, your collateralization ratio rises (the value of your collateral relative to your loan decreases). If it falls below the protocol’s liquidation threshold (commonly 150%–200%), your collateral may be automatically liquidated to repay debt. To avoid this scenario, you can add more collateral or repay part of your loan in advance.

Why Does DeFi Require Overcollateralization Instead of Equal Collateralization?

DeFi relies on overcollateralization due to crypto’s high volatility. With 1:1 equal-value collateralization, a 10% price drop wipes out the protocol’s ability to recover funds. Overcollateralizing (e.g., at 150%) creates a buffer that protects creditors even in volatile markets. While this reduces capital efficiency, it greatly lowers bad debt risk.

Which Assets Are Best Suited for Collateral in DeFi?

Top DeFi collaterals have three features: stable value (e.g., USDC, USDT), high liquidity (easy to liquidate), and manageable risk. Mainstream choices include stablecoins, major cryptocurrencies (BTC, ETH), and native public chain tokens. Gate supports various compliant assets as collateral—choose reputable coins with high trading volumes for optimal borrowing terms.

How Do I Set Collateral in Gate’s Lending Products?

On Gate Lending, first select your desired loan currency and amount; the system will recommend suitable types and amounts of collateral. Transfer these assets into your lending account as collateral. Once you meet the required collateralization ratio, you can receive your loan. The entire process takes place within the Gate app—with real-time monitoring of your ratio changes and risk alerts.