GlossaryAdvanced
Bad Debt
Debt in a lending protocol that exceeds the value of its remaining collateral, meaning liquidation can no longer fully cover what's owed.
Bad debt occurs in a lending protocol when a borrowed position's outstanding debt exceeds the current value of its remaining collateral, meaning liquidation can no longer fully recover what's owed — generally the result of a collateral price falling faster than the protocol's liquidation mechanism could react.
Accumulated bad debt is a real, documented risk for DeFi lending protocols, since it represents a loss that typically must eventually be absorbed by the protocol's own reserves, its other depositors, or its token holders, rather than simply disappearing.
Examples
- A sudden, sharp collateral price crash can outpace a protocol's liquidation mechanism, leaving bad debt that liquidating the remaining collateral can no longer fully cover.
- Accumulated bad debt in a lending protocol generally has to be absorbed by its own reserves or other stakeholders, not simply written off with no consequence.