Have you ever wondered: why do you need to post more than $100 of collateral to borrow $100 of stablecoins? Locking $150 of ETH to mint 100 DAI sounds inefficient, but that “extra $50” is exactly the design that lets decentralized stablecoins hold $1 even when crypto prices crash.
The Collateral Ratio is the value of what you lock up divided by the amount of Stablecoin you borrow. Say ETH is $3,000 and you lock 0.05 ETH (worth $150) to borrow 100 USDS; the CR is 150 ÷ 100 = 150%. Your collateral exceeds your debt by 50% — that excess is the safety buffer. Different protocols set different minimum CRs; MakerDAO (now Sky) has maintained 150% on ETH vaults for years, while some aggressive protocols allow lower CRs for higher capital efficiency at the cost of more Liquidation risk.
Here’s the key: liquidation doesn’t wait for collateral to fall equal to the debt — it triggers while there’s still a buffer. For Sky, the ETH vault liquidation threshold is typically set at 125–130%. This means if you locked $150 of ETH to borrow $100 USDS, once ETH falls enough that your CR touches 130% (collateral down to $130), the system auto-sells your ETH — first repaying your $100 USDS debt (plus a liquidation penalty), then returning the remaining ETH to you. Why the early trigger? Because crypto markets can fall 20–30% in hours; if the system waited until collateral equalled $100 exactly, violent market moves could leave the protocol unable to collect the full debt, creating bad debt. Early liquidation ensures the protocol always fully recovers what it’s owed, keeping USDS pinned to $1.
It comes from a worst-case stress test. The designers ask: in a crash, how much time does the system need from spotting the problem to executing liquidation? In extreme volatility, the safe window for a keeper bot to operate is considered to be within a price drop of roughly 20–30%. Add that to the liquidation threshold (e.g. 130%) and you get the 150% initial minimum CR. History validated this: in the 2022 crypto bear market the largest single-day drop exceeded 40%. Sky triggered massive liquidations but, because the buffer was sufficient, the protocol itself saw no serious bad debt and DAI’s peg held through the storm.
Whether you mint USDS or only hold it, overcollateralization quietly protects your $1 in the background. As a holder, understand this: as long as the protocol’s overall collateral ratio stays healthy, USDS’s $1 is backed by real assets, not an empty promise. You can check the Global CR on Sky’s dashboard anytime — only if a market crash causes significant bad debt and the CR visibly declines should you consider whether to exit USDS. As a minter, remember: liquidation isn’t punishment, it’s the mechanism that protects the protocol. Keeping your personal CR well above the liquidation threshold is the most fundamental discipline in DeFi lending.