A general definition of collateral
Have you ever stumbled into the word “collateral”? Are you still trying to understand its meaning? No worries. Read below and you will have all that it takes to comprehend the word.
A general definition of collateral
A collateral is an asset accepted by a lender as a security for a loan. It can be any kind of asset. It always depends on the purpose of the loan. In its broadest definition, a collateral is nothing more than something a lender uses in order to protect his loan.
What is a loan?
The practice of lending has a long story, even dating back to ancient Greece. Throughout the centuries, this practice evolved and took many different forms. You are perfectly aware of what the word “loan” means. A loan is simply money lent by someone to someone. In recent times, with the advent of blockchain systems, loans have begun to change drastically. They are becoming one of the most common processes in the crypto world due to the increasing number of people investing in them.
No lender will ever issue you a loan, if he doesn’t know that you can repay it. But how can you assure them that you’ve always repaid all your debts on time? You both need a type of security. You need, in other words, a collateral.
This security reduces the risk for lenders and helps to ensure that the borrower will observe his obligation. What if the borrower cannot be able to repay the loan? In this case, the lender can sell the collateral, applying the money it gets to the unpaid portion of the loan. If needed, the lender can choose to pursue legal action against the borrower to recoup any balance remaining.
Types of collateral
A collateral can be many different assets, depending on the nature of the loan. Collaterals usually include:
- Personal property
- Real estate
- Paper collateral
- Valuables and collectibles
Residential mortgages: an example of collateral
The most popular example of collateral relates to residential mortgages. In this case, the mortgage is a loan, and the house is the collateral. If the homeowner stops paying the mortgage, the lender can begin legal proceedings so as to take possession of the house (foreclosure). Then, they can sell the house to repay the rest of the loan.
Cryptocurrency loans
In the example above we have seen that, in order to secure funding from a bank, a collateral requires giving an asset. With cryptocurrency collaterals, on the other hand, you are not required to stake your personal assets. So what do you stake?
The answer is simple: you use your cryptocurrency tokens and receive a fiat or digital currency loan. This loan depends on the type of your assets. Blockchain-based loans are extremely fast and reliable, because they operate on systems that are immutable, decentralized databases that are trustworthy.
