'DeFi's Collateralized Debt Protocols' cc: sora_xor defi decentralization
In legacy financial systems, collateralized debt obligations are, somewhat, complex structured finance products, usually backed by a pool of loans or other assets. These underlying assets serve as collateral should the loan go into default. Though risky and not for all investors, CDOs are generally regarded as a legitimate tool for shifting risk and freeing up capital by financial participants in the traditional finance system.
CDPs can be thought of as vaults for storing collateral. To account for the volatility of a collateralized digital asset, DAI is usually over-collateralized, meaning that the deposit amount required is typically higher than the value of DAI. For example, users must lock $20,000 worth of ether in order to receive $10,000 DAI, which is meant to account for the potential decrease in the value of the collateral.
However, solutions that deploy CDPs across more than one chain have to make use of ‘bridges’, often on a mint and burn system. The user - or the protocol - deposits a token into the bridge and it mints the version of that token on the other side of the bridge. Several bridges in the past were hacked, and user funds were drained. As such, investors into CDPs should be aware of the heightened risk these particular solutions might carry.
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