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What is Collateralized Debt Position (CDP)? How does it Work?
The Web3 Telegraph
June 11, 2024
A Collateralized Debt Position (CDP) is a specific mechanism used to secure a loan, where a borrower locks up collateral to mint or borrow a new asset, often a stablecoin.
According to DeFi Llama, there are 143 CDP protocols with a combined TVL of $10.035b. Some notable giants in the space include MakerDAO with a TVL of $6.077b, JustStables $1.348b, Liquity $547.72m etc.
The main aim of CDP is to generate liquidity (often in the form of a stablecoins) without selling the underlying asset. This allows borrowers to retain exposure to the potential appreciation of the collateral.
Example: MakerDAO is a notable example. Users deposit Ether (ETH) as collateral into a CDP to generate DAI, a stablecoin. The amount of DAI generated is less than the value of the ETH deposited, creating a secure borrowing scenario.
Similar to over collateralized borrowing, if the value of the collateral drops too much, the CDP can be liquidated to cover the borrowed amount.
Is Crypto Collateralized Debt Positioning similar to Over Collateralized Borrowing?
Short answer, No!
While both CDPs and Over Collateralized Borrowing require collateral, overcollateralized borrowing typically demands more collateral than the loan amount. Furthermore, CDPs also involve locking collateral to generate new tokens, often stablecoins.
The tabular comparison below explains the difference between the two mechanisms.
Parameter | Collateralized Debt Position (CDP) | Over Collateralized Borrowing (OCB) |
|---|---|---|
Definition | Mechanism to lock collateral to mint/borrow a new asset, often a stablecoin | Lending method where collateral exceeds loan value |
Primary Purpose | Generate liquidity without selling the underlying asset | Minimize lender's risk |
Collateral Requirement | Lock collateral to generate new tokens (e.g., stablecoins) | More collateral than the loan amount |
Example: | MakerDAO | Aave, Compound |
How does it Work?
Textbook Example: MakerDAO
Source: https://app.spark.fi/
Deposit Collateral: The user selects the type of collateral (e.g., wstETH)
Generate Debt: The user inputs the amount of DAI they wish to borrow in the "Borrow" section of the interface. The platform calculates the required collateral and ensures it meets the Loan to Value (LTV) ratio requirements. The borrow rate is displayed (e.g., 9.00%).
Monitor Collateral Value: The MakerDAO interface provides a Loan to Value (LTV) bar indicating the current LTV ratio and the thresholds for conservative, moderate, aggressive, and liquidation levels. Users need to monitor this bar regularly to ensure their collateral value does not approach the liquidation threshold.
Liquidation: The liquidation process is triggered automatically by the MakerDAO system if the collateral value falls below the required threshold. The interface would show a warning if the user's collateral is nearing the liquidation point.
Repayment & Withdrawal: The user repays the borrowed amount plus stability fees to unlock and withdraw the remaining ETH.
Conclusion:
Collateralized Debt Positions (CDPs) are a pivotal innovation in the decentralized finance (DeFi) ecosystem, providing users with the ability to generate liquidity without selling their underlying assets. This mechanism not only allows borrowers to maintain exposure to potential asset appreciation but also creates a secure environment for borrowing through over-collateralization and automatic liquidation protocols.
The popularity of CDPs is evident in the substantial total value locked (TVL) in various protocols, with MakerDAO being a leading example. As the DeFi space continues to evolve, understanding the nuances of mechanisms like CDPs will be crucial for users and investors aiming to maximize their participation in decentralized finance while managing associated risks effectively.