Collateral Tokens are cryptocurrencies used as security to borrow other cryptocurrencies or assets in decentralized finance (DeFi) protocols. They play a vital role in the DeFi ecosystem by enabling users to access liquidity without selling their holdings.

Think of it like taking out a loan at a bank. When you take out a loan, you typically have to provide collateral in the form of your house, car, or other valuable assets. Similarly, in DeFi, you can use cryptocurrency assets as collateral to borrow other cryptocurrencies or assets.

Collateral Tokens are locked up in the DeFi protocol as security for the loan. If the value of the collateral tokens drops below a certain threshold, the protocol may automatically liquidate the collateral to recoup its losses. This process helps protect lenders from potential losses and ensures the stability of the DeFi protocol.

The types of assets that can be used as Collateral Tokens vary depending on the DeFi protocol. Common examples include:

• Stablecoins: Stablecoins are cryptocurrencies pegged to a fiat currency or other real-world assets, such as the US dollar or gold. They are considered less volatile than other cryptocurrencies, making them a popular choice for collateral.
• Ethereum (ETH): ETH is the native cryptocurrency of the Ethereum blockchain, and it is widely used as collateral in DeFi protocols due to its liquidity and stability.
• Bitcoin (BTC): BTC is the first and most popular cryptocurrency, and it is also used as collateral in some DeFi protocols. However, its volatility can make it a riskier choice for collateral.

Understanding Collateral Tokens is essential for web3 beginners who want to participate in DeFi lending and borrowing. It allows them to leverage their existing cryptocurrency holdings to access liquidity without selling their assets.