Over-Collateralization
Requiring a borrower to lock collateral worth more than the amount borrowed, so the loan stays covered if prices move.
On-chain lenders cannot assess a borrower's identity, income, or credit history, and cannot pursue an unpaid debt in court, so the loan must be secured by assets the contract can seize and sell automatically. The size of the required buffer reflects how volatile and how liquid the collateral is, with a widely traded asset permitting a smaller cushion than a thin one. The same principle underpins crypto-collateralized stablecoins, where locked collateral exceeds the value of tokens issued against it. The cost of this design is capital efficiency: borrowers must lock more value than they receive, which is why on-chain credit has not replaced conventional lending.
In practice
A borrower locking a volatile asset may be able to draw only a fraction of its value as a loan, with the remainder acting as the buffer against price moves.
The common misunderstanding
Over-collateralization protects the lender rather than the borrower; it does nothing to prevent the borrower's collateral from being sold at an unfavorable moment.