CDP (Collateralized Debt Position)

How a CDP works

The classic CDP, popularized by MakerDAO, works in four steps:

1. Deposit collateral — the user locks an asset (originally ETH; now also wBTC, stablecoins, real-world assets, and others) into a smart contract.
2. Mint new debt — against the locked collateral, the user mints a stablecoin (DAI in MakerDAO's case) up to a maximum loan-to-value ratio. ETH might allow 60-70% LTV; more volatile collateral allows less.
3. Hold or use the borrowed asset — the user can spend the DAI, swap it, or use it elsewhere in DeFi.
4. Close the position — return the borrowed amount plus a stability fee (interest) to unlock the collateral.

If collateral value falls or debt accrues enough that the position crosses a liquidation threshold, automated liquidators step in: they repay part of the debt and seize a proportional chunk of collateral plus a penalty.

Why the design matters

CDPs were one of DeFi's foundational primitives. They solved a structural problem in crypto: how to issue a stablecoin without a centralized issuer or a custodial reserve.

A CDP-issued stablecoin like DAI is fully backed by over-collateralized crypto positions — anyone can verify the backing on-chain, and there's no trusted party who could mint extras or freeze redemptions. This is meaningfully different from fiat-backed stablecoins (USDC, USDT) where users have to trust the issuer's custody and reserves.

The trade-off: CDP stablecoins consume more capital than fiat-backed alternatives, since each $1 of stablecoin requires significantly more than $1 of locked collateral. They also share the systemic risk of crypto markets — a deep bear market cascades through CDP liquidations.

Beyond stablecoins

The CDP pattern generalizes to any over-collateralized borrowing:

• Aave and Compound — same basic mechanic, but borrowers can mint any supported asset rather than just a stablecoin. Each user effectively maintains a CDP-like position.
• Liquity — interest-free CDPs against ETH that mint LUSD stablecoin.
• Frax — partially algorithmic stablecoin design that uses CDPs alongside other mechanisms.
• Real-world asset CDPs — newer experiments lock tokenized treasuries or real estate as collateral.

Risks specific to CDPs

The classic failure modes:

• Cascading liquidations. A sharp price drop liquidates positions, the resulting forced selling pushes prices lower, more liquidations trigger. March 2020's "Black Thursday" caused mass MakerDAO liquidations, and a network outage temporarily allowed liquidators to seize collateral at zero cost.
• Stability-fee changes. MakerDAO governance can change the stability fee on existing CDPs, sometimes dramatically. CDP holders are exposed to this risk after opening the position.
• Oracle failure. CDPs rely on price oracles to determine when liquidation triggers. Bad oracle data can cause inappropriate liquidations or allow under-collateralized borrowing.

CDPs vs. flash loans

CDPs and flash loans are two ends of the DeFi borrowing spectrum. CDPs hold collateral indefinitely, allow open-ended borrowing, and require active management. Flash loans hold no collateral, must be repaid within a single transaction, and require no management. Both occupy real niches — CDPs for ongoing leverage, flash loans for atomic operations like arbitrage and refinancing.