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Undercollateralized Lending

1 min read
Pronunciation
[uhn-der-kaw-lat-er-uh-ligh-zay-d len-ding]
Analogy
Like a bank issuing loans based on your credit score rather than full collateral, trusting your history to repay.
Definition
Lending where borrowers post less collateral than the principal, relying on credit assessments or reputation systems to manage risk.
Key Points Intro
Undercollateralized lending extends credit but introduces borrower default risk.
Key Points

Credit assessment: uses on-chain history or KYC data

Reputation: relies on borrower’s信誉 or identity oracles

Interest premiums: higher rates to compensate risk

Settlement: smart contracts enforce repayment schedules

Example
A DeFi protocol issues short-term loans to vetted borrowers using reputation oracles, requiring only 50% collateral and higher interest rates.
Technical Deep Dive
Protocols integrate credit-scoring oracles that aggregate on-chain behavior and off-chain KYC. Lending contracts lock collateral, track repayment deadlines, and trigger collateral seizure via governance or oracle triggers upon defaults.
Security Warning
Defaults in undercollateralized lending can deplete protocol reserves and harm depositors.
Caveat
Requires robust borrower vetting and legal enforceability in case of default.
Related Terms
Under-collateralization
Reputation Oracle

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