Collateral Ratio

What is Collateral Ratio?

The collateral ratio is the percentage value of an asset deposited as collateral compared to the value of the loan taken against it. It measures the "health" and safety of a debt position.

How does Collateral Ratio work?

1. It is calculated using the formula:

   (Total Value of Collateral / Total Value of Loan) * 100

2. For example, if you deposit $200 of ETH to borrow $100 of USDC, your collateral ratio is 200%.

3. Protocols set a "Minimum Collateral Ratio" (e.g., 150%).

4. If your ratio falls below this minimum due to price changes, your position is liquidated.

5. A higher ratio provides a larger "buffer" against market volatility.

Why does Collateral Ratio matter?

It is the most important metric for a borrower to monitor in DeFi. A healthy collateral ratio prevents liquidation, while a protocol-wide healthy ratio ensures that the lending platform remains solvent.

Key features of Collateral Ratio

• Direct indicator of liquidation risk
• Dynamic, changing with market prices
• Expressed as a percentage
• Determined by protocol risk parameters
• Protects the lender's capital

Examples of Collateral Ratio

• A 150% collateral ratio required by MakerDAO to mint the DAI stablecoin.
• A borrower adding more ETH to their Aave position to increase their ratio during a market dip.
• A protocol with a 110% ratio, which is considered high-risk but high-efficiency.