Undercollateralized Loan
A loan where the collateral posted is worth less than the amount borrowed, the exception rather than the rule in most current DeFi lending.
An undercollateralized loan is a loan where the collateral posted is worth less than the amount actually borrowed — the structural opposite of the over-collateralization (see Kaavon's "Over-Collateralization" glossary definition) model that most current DeFi lending protocols rely on by default.
Undercollateralized lending in DeFi generally requires some additional mechanism to manage the resulting default risk that over-collateralization otherwise handles automatically — such as a credit-scoring system, a trusted-counterparty whitelist, or a flash loan's (see Kaavon's "Flash Loan" glossary definition) atomic same-transaction repayment guarantee, which is itself a form of effectively zero-collateral, undercollateralized borrowing.
Examples
- A flash loan is effectively a form of undercollateralized borrowing, made safe only by its atomic same-transaction repayment guarantee rather than posted collateral.
- Undercollateralized lending generally requires some additional mechanism, like credit scoring or a trusted-counterparty whitelist, to manage the default risk collateral alone would otherwise cover.