Collateral

A bank asks for a house before lending against it. DeFi has no loan officers and no courts to chase late payers, so it asks for something simpler: assets locked up front, worth more than what is borrowed, that code can sell the moment the numbers stop adding up. That locked asset is collateral, and almost everything in DeFi rests on it.

Collateral in lending

In a money market, a borrower supplies collateral and borrows a different asset against it. Each market sets a maximum loan-to-value: how much can be borrowed for each dollar of collateral. Suppose a market allows borrowing up to 80 cents per dollar of ETH. A borrower supplies 10,000 dollars of ETH and borrows 6,000 dollars of a dollar token. If ETH falls and the collateral is worth 7,500 dollars, the loan has reached 80 cents per dollar and the position can be liquidated: part of the collateral is sold to repay the debt, with a penalty, and the borrower keeps what is left.

Collateral behind tokens

Dollar tokens use collateral in different ways. A fiat-backed stablecoin holds cash and government debt. Crypto-backed designs lock more crypto than the tokens they issue, a buffer known as overcollateralization. A synthetic dollar combines collateral with offsetting positions, so the value of the whole holds steady even when its parts move.

How collateral is valued

Smart contracts cannot see markets directly. They learn an asset's price from an oracle, and that price decides when liquidations happen. A wrong or manipulated price can trigger liquidations that should not happen, or block ones that should. This is why lending markets weigh oracle design carefully for every asset they accept.

Where collateral sits

Location matters as much as quality. Collateral locked in a smart contract can be checked by anyone at any time and sold by code, but it is exposed to bugs in that contract. Collateral held offchain, with a custodian or an exchange, avoids that code risk but depends on the institution holding it and on how often its balances are reported. Many designs mix the two, which makes clear reporting on each part all the more important.

What makes collateral good

• Liquidity: it can be sold quickly in size without crashing its own price.
• Price stability: smaller swings mean thinner safety margins are enough.
• Transparency: holdings can be checked, ideally through proof of reserves.
• Independence: it does not fall at the same moment as the thing it protects.

Risks and limits

Collateral protects lenders and holders only as well as it can be sold. In a crash many positions are liquidated at once, buyers thin out and prices fall further, so a buffer that looked comfortable can vanish. Collateral reused across several protocols links their failures together. And a ratio describes today's prices, not tomorrow's. A collateral ratio is where the analysis starts, not where it ends.

trUSD, Tori Finance's synthetic dollar, is collateralized by USDC/USDT. The reserves can be checked through Accountable's proof of reserves at tori.accountable.capital.