An overview of how stablecoins enable users to unlock liquidity from their holdings to borrow other digital assets, creating new opportunities for leverage, trading, and yield generation without selling their core positions.
LABS
Using Stablecoins as Collateral for Borrowing Other Assets
Chainscore © 2025
Core Concepts of Collateralized Borrowing
Overcollateralization
Overcollateralization is the practice of depositing more collateral value than the loan amount to protect lenders from price volatility. This creates a safety buffer.
- A user deposits $150 worth of USDC to borrow $100 worth of ETH.
- If the collateral's value drops, the buffer absorbs losses before triggering liquidation.
- This mechanism is fundamental to maintaining protocol solvency and user trust in decentralized finance.
Collateral Factor & Loan-to-Value (LTV)
The Collateral Factor determines the maximum Loan-to-Value (LTV) ratio, which is the percentage of your collateral's value you can borrow against.
- A platform may set a 75% LTV for USDC, allowing a $750 loan against a $1,000 deposit.
- A lower LTV ratio means a larger safety margin against liquidation.
- Users must monitor their LTV to manage risk, especially during market downturns.
Liquidation & Health Factor
Liquidation occurs if your collateral value falls too close to your loan value, triggered by a low Health Factor. This automated process sells collateral to repay the loan.
- A Health Factor below 1.0 typically initiates liquidation.
- Example: If ETH's price crashes, your USDC-backed loan might be liquidated to cover the debt.
- Maintaining a high Health Factor is crucial to avoid forced asset sales at unfavorable prices.
Interest Rates & Yield
Borrowing incurs a dynamic interest rate, often based on pool utilization. Meanwhile, deposited stablecoins may earn a yield from being lent to other users.
- Borrowing rates can be variable or stable, influenced by market demand.
- A user might earn 3% APY on deposited DAI while paying 5% to borrow WBTC for a trading strategy.
- This creates complex yield farming strategies where users arbitrage the rate differential.
Use Case: Leveraged Trading
Using stablecoins as collateral allows for leveraged trading strategies without needing extra capital from outside the crypto ecosystem.
- A trader deposits USDT, borrows more of an altcoin to amplify potential gains (or losses).
- This avoids taxable events from selling appreciated assets to raise trading funds.
- It enables sophisticated strategies like going long on volatile assets while maintaining a stablecoin base position.
Use Case: Liquidity Provision & Farming
Users can leverage collateralized borrowing to enhance yield farming returns by recycling capital.
- Deposit USDC as collateral, borrow a governance token like UNI, and then supply both to a liquidity pool for double rewards.
- This "leveraged farming" increases exposure and potential APY but also amplifies impermanent loss risk.
- It maximizes capital efficiency by using the same asset for both collateral and yield generation.
The Technical Process: From Deposit to Withdrawal
A technical walkthrough of using stablecoins as collateral to borrow other crypto assets on a decentralized lending platform.
1
Step 1: Connect Wallet & Approve Collateral
Connect your Web3 wallet and grant the smart contract permission to access your stablecoins.
Detailed Instructions
First, you must connect a Web3 wallet like MetaMask to the lending platform's interface. This establishes your on-chain identity. The core action is granting spending approval to the platform's smart contract for the stablecoin you wish to deposit (e.g., USDC, DAI). This is a token allowance transaction, not a transfer, and is required for the contract to later move your funds. You must specify the exact contract address of the stablecoin and the address of the lending protocol's core vault.
- Sub-step 1: Navigate to the platform and click "Connect Wallet". Select your provider and sign the connection request.
- Sub-step 2: Select your collateral asset (e.g., USDC) and initiate the "Approve" action. The interface will typically show the contract address
0xA0b86991c6218b36c1d19D4a2e9Eb0cE3606eB48for USDC on Ethereum. - Sub-step 3: In your wallet, confirm the transaction. Review the gas fee and the
spenderaddress (the lending contract). The transaction call will resembleapprove(spender, amount).
Tip: You can approve a specific amount or use
type(uint256).maxfor an infinite allowance to save gas on future deposits. Always verify contract addresses from official sources.
2
Step 2: Deposit Collateral & Determine Health Factor
Lock your stablecoins into the protocol's smart contract and understand your borrowing capacity.
Detailed Instructions
After approval, execute the deposit transaction to transfer your stablecoins to the protocol's liquidity pool. This action mints a collateral token (often an interest-bearing cToken or aToken) to your wallet, representing your share. Concurrently, the protocol calculates your Health Factor (HF), a critical metric that determines your loan's safety. HF is calculated as (Collateral Value * Liquidation Threshold) / Borrowed Value. A HF below 1.0 risks liquidation. The Loan-to-Value (LTV) ratio dictates how much you can borrow against your collateral.
- Sub-step 1: On the platform, enter the amount of USDC to deposit (e.g., 10,000 USDC) and submit the
supply()ordeposit()transaction. - Sub-step 2: Confirm the transaction in your wallet. You will receive a token like
cUSDCoraUSDC. - Sub-step 3: Observe your updated dashboard. Your initial HF will be infinite (∞) as you have no debt. Note the Liquidation Threshold for USDC, which might be 85%, meaning you can borrow up to 85% of its value.
Tip: Monitor your HF closely. On Compound, you can check it via
Comptroller.getAccountLiquidity(yourAddress). Keeping HF well above 1.5 (e.g., 2.0) is a safe practice.
3
Step 3: Borrow Target Asset
Execute the borrow function to receive the desired asset, such as ETH or WBTC, into your wallet.
Detailed Instructions
With collateral active, you can now borrow a different asset. You call the protocol's borrow() function, specifying the asset's contract address and amount. The smart contract checks that the new borrow does not push your Health Factor below 1.0. If successful, the borrowed tokens are sent directly to your wallet. This creates a debt position that accrues interest based on the asset's current borrow rate, which is variable and determined by pool utilization.
- Sub-step 1: Select the asset to borrow (e.g., Wrapped ETH -
0xC02aaA39b223FE8D0A0e5C4F27eAD9083C756Cc2). - Sub-step 2: Enter the borrow amount. The interface will show the maximum available based on your collateral and the dynamic borrow rate (e.g., 3.2% APY).
- Sub-step 3: Submit the
borrow(assetAddress, amount)transaction. For example, borrowing 2 ETH:borrow(0xC02aaA39..., 2000000000000000000). - Sub-step 4: Verify the borrowed assets arrive in your wallet and confirm your updated, lowered Health Factor on the dashboard.
Tip: Borrowing near your maximum LTV will result in a HF very close to 1, making you highly susceptible to small market movements and liquidation.
4
Step 4: Monitor, Repay, or Withdraw
Manage your position by repaying debt to unlock collateral or withdrawing excess collateral.
Detailed Instructions
Ongoing management is crucial. You must monitor your Health Factor as collateral and borrowed asset prices fluctuate. To reduce risk or close the position, you can repay the borrowed assets plus accrued interest. Repaying debt improves your HF. Once debt is fully repaid, you can withdraw your original collateral. The repayBorrow() and redeemUnderlying() (or withdraw()) functions are used. Some protocols require you to approve the borrowed token for repayment, similar to Step 1.
- Sub-step 1: To repay, first ensure you hold the borrowed asset (e.g., ETH). Approve the lending contract to spend it if necessary.
- Sub-step 2: Call
repayBorrow(assetAddress, amount). Repaying the full amount might require fetching your current borrow balance viagetBorrowBalance(yourAddress). - Sub-step 3: After repayment, your debt is zero. You can then call
redeemUnderlying(amount)on your cUSDC token to convert it back to USDC and send it to your wallet. - Sub-step 4: Always verify the final state: debt balance should be 0, and your wallet should hold the returned stablecoins.
Tip: Use a blockchain explorer to directly query your position's state. For a Compound cToken, call
borrowBalanceCurrent(yourAddress)on the cToken contract to get the precise, interest-accrued debt.
Stablecoin Collateral Parameters Across Major Protocols
Comparison overview
| Protocol | Collateral Stablecoin | Max LTV (%) | Liquidation Threshold (%) | Stability Fee (APY) |
|---|---|---|---|---|
MakerDAO | DAI | 110 | 150 | 1.5% |
Aave V3 (Ethereum) | USDC | 80 | 85 | Variable (~2-5%) |
Compound V3 | USDT | 75 | 80 | 0% (Base Rate) |
Liquity | LUSD | 110 | 110 | 0.5% |
Frax Finance | FRAX | 92 | 95 | Variable (~3-8%) |
Abracadabra.money | MIM | 90 | 93 | 0% (Base Rate) |
Curve Lending (LLAMMA) | crvUSD | 95 | 100 | Variable (~1-4%) |
Risk Analysis: Borrower vs. Protocol Perspective
Primary Borrower Risks
When using stablecoins like USDC or DAI as collateral to borrow other assets (e.g., ETH), the borrower's main concern is liquidation risk. If the value of the borrowed asset surges relative to the stablecoin collateral, the loan's health factor drops, triggering automatic liquidation.
Key Risks to Manage
- Collateral Volatility: While stablecoins aim for a $1 peg, de-pegging events (like USDC's temporary drop in March 2023) can cause sudden, unexpected liquidations.
- Liquidation Penalties: Protocols like Aave and Compound charge fees (e.g., 5-10%) on liquidated amounts, eroding the borrower's collateral.
- Interest Rate Risk: Variable borrowing rates on platforms can spike during market stress, increasing costs unexpectedly.
Real-World Scenario
A borrower deposits 10,000 USDC on Compound to borrow 5 ETH. If ETH's price doubles, the loan's collateral ratio worsens. If the health factor falls below 1, a liquidator can repay part of the debt at a discount, seizing the borrower's USDC. The borrower must actively monitor prices or use automated tools to avoid this.
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