Good morning.
I’m Mitsui, a web3 researcher.
Every Saturday and Sunday at noon, we’ll deliver articles explaining basic vocabulary. We aim to keep each article concise enough for a quick read, while also providing content you can revisit and study.
Today’s topic is “collateral.”
Please watch until the very end!
Why is “collateral” the starting point of finance?
The most fundamental activity underlying the financial system is “borrowing and lending.” Yet this simple act conceals complex issues: the issues of “credit” and “risk.” Lenders must trust the promise that the money lent will be repaid. But how is that trust formed?
This is where the concept of “collateral” comes into play.
Collateral is a technique where lenders “guarantee the borrower’s creditworthiness in another form.” Rather than taking the borrower’s word, it reduces the lender’s risk by securing assets in advance that can be sold if repayment fails. In fact, web3 lending protocols (such as Aave and MakerDAO) also faithfully inherit this fundamental banking model.
In other words, understanding the mechanism of collateral can be considered the most fundamental principle that underlies both traditional finance and Web3.
What is collateral?
Collateral is a guarantee that lenders use to reduce risk. Specifically, it refers to assets that lenders can sell or recover if the borrower becomes unable to repay.
The existence of collateral enables something innovative: even those with low credit scores can borrow.
From the bank’s perspective, if a borrower has low creditworthiness, they would typically refuse to lend. However, if sufficient collateral is available, the risk is offset by the collateral’s value, making lending possible. This is a key concept in financial inclusion.
Historically, secured loans have enabled people with low credit scores to gain access to capital. From microfinance to mortgages, the collateral model has supported the democratization of finance.
Keep reading with a 7-day free trial
Subscribe to DEBUNK（web3 Research） to keep reading this post and get 7 days of free access to the full post archives.