Definition
Collateral ratio is a risk metric used in decentralized finance to express how much collateral backs a given amount of debt or issued tokens, usually as a percentage. It compares the market value of the collateral locked in a protocol to the value of the liabilities, such as borrowed assets or minted stablecoins. A higher collateral ratio indicates that the position is more heavily backed relative to its debt, while a lower ratio signals that the position is closer to being undercollateralized.
In systems that issue a stablecoin, the collateral ratio helps determine how robust the backing is for that stablecoin. Protocols often define minimum required collateral ratios, below which positions may be liquidated or otherwise adjusted to protect the system. The ratio is typically recalculated continuously or frequently, reflecting price changes in both the collateral and the liabilities.
Context and Usage
Collateral ratio is central to the design of many stablecoin protocols, including those that issue assets like DAI, FRAX, or USDC-backed instruments. For overcollateralized stablecoins, the ratio indicates how much more value in collateral exists compared with the stablecoin supply, supporting the maintenance of the peg. In partially collateralized or algorithmic designs, the collateral ratio may vary over time as market conditions and protocol rules adjust the mix of collateral and other backing mechanisms.
The concept is used at both the individual position level and the system-wide level. At the position level, a user’s vault or loan has its own collateral ratio that determines its safety relative to liquidation thresholds. At the system level, an aggregate collateral ratio measures the total collateral value versus total outstanding stablecoins, serving as an indicator of the protocol’s overall solvency and resilience.