Collateral

Collateral refers to the asset(s) backing a loan pledged by a borrowing entity to offset the lending entity's risk.

In traditional (e.g., off-chain) finance, a defaulted loan is subject to a complex debt collection process that may involve third parties, legal proceedings, and/or credit assessments. In traditional finance, loans are commonly undercollateralized (when a loan's collateral amount is less than its outstanding balance).

In some cases of decentralized finance (DeFi), defaulting loans are automatically made whole (barring smart contract exploit/failure) due to the use of over-collateralization (when a loan's collateral amount is greater than its outstanding balance) at loan origination; see also: 'collateralized debt position'.