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Collateral Debt Position

Updated: Aug 18, 2023

Collateral debt position also known as CDPs, are a type of overcollateralized loan that allows users to create debt by

providing an asset as collateral.

This is a popular mechanism for minting decentralized stable coins, which are digital assets that are pegged to a stable value, such as the US dollar. Unlike traditional lending and borrowing, where the interest rate is determined by the demand for a particular asset, CDPs have fixed interest rates, as the stable coins they mint are considered debt.

To better understand how CDPs work, let's consider a scenario where you go to a bar and open a tab with the bartender. You ask for a beer, which costs $5, but you don't pay for it until you close the tab. This creates a debt with the bartender, as you have received a beer without paying for it. A CDP functions in a similar way, allowing you to open a tab by providing an asset as collateral. This ensures that you won't run off without paying back your debt. Once you open a tab, you can borrow up to the value of the collateral you have put up, hence the term "overcollateralized loan."

If the value of the collateral falls below a certain threshold (known as the liquidation threshold), the platform's smart contracts are triggered to automatically liquidate a portion of the collateral. The liquidated assets are then sold on the market to recover the debt.

There are many CDP dapps available, including MakerDAO (DAI), QIDAO (MAI), and (MIM). These platforms offer users the ability to create debt and mint stable coins by providing collateral, typically in the form of cryptocurrency such as Ethereum.

This can be a useful tool for those seeking to hedge against volatility in the cryptocurrency market, as stable coins offer a stable store of value. However, it's important to note that CDPs do come with risks, as the value of your collateral may decrease and you may be required to add additional collateral in order to maintain a sufficient level of overcollateralization or get liquidated.

To get to know more about collateral debt obligation and learn how to effectively use this decentralized application, enrol to one of our courses at CryptoAx07. From creating a wallet to using DeFi protocols safely, our course will provide you with all the necessary skills and knowledge to get started.

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