Every major on-chain lending market requires collateral worth more than the loan. That looks inefficient until you consider what a lender can do when a borrower simply stops paying.
There is no borrower to pursue
Conventional lending rests on identity, credit history and the ability to enforce a claim through courts. A borrowing address supplies none of that.
If the position goes bad, there is nothing to seize beyond what was posted and nobody to sue. Recovery is limited to the collateral by construction.
Overcollateralisation is therefore not conservatism. It is the only enforcement mechanism the system has.
The buffer absorbs price movement and execution cost
Collateral is usually a volatile asset, and its value can fall between the moment a position becomes unsafe and the moment it is closed.
The excess must cover that gap plus the cost of selling into a market that may be moving against the liquidator.
Assets with thinner liquidity or higher volatility therefore carry stricter ratios, and the parameters are set per asset rather than uniformly.
Liquidation is incentivised, not administered
No entity monitors positions. Instead the protocol offers a discount to anyone who repays part of an unhealthy loan and takes collateral in exchange.
That discount has to be large enough to attract participants who will build monitoring infrastructure and hold capital ready.
Setting it too low leaves bad positions unclosed during volatility, and setting it too high transfers more value from borrowers than the risk warrants.
Oracles determine when the trigger fires
The protocol needs an external price to judge whether a position is safe, and that price comes from an oracle rather than from the chain itself.
A stale price delays liquidations until the collateral is already insufficient, and a manipulated price triggers liquidations that should not have happened.
Most large losses in on-chain lending trace back to this component rather than to the lending logic, which is why oracle design receives disproportionate attention.
Undercollateralised lending needs something extra
Lending against less collateral requires reintroducing what was removed: identity, legal agreements, or a whitelisted borrower with a reputation to protect.
Designs doing this generally serve institutional borrowers under off-chain contracts, with the chain used for settlement rather than for enforcement.
The distinction is worth keeping clear, because a protocol that lends without full collateral is relying on something outside the code to make the loan repayable.