Collateralized Debt Position (CDP)

A Collateralized Debt Position, often called a CDP, is a way to borrow cryptocurrency by locking up other cryptocurrency as collateral. You deposit an asset — say, Ether — into a smart contract, and the contract allows you to borrow a different asset, typically a stablecoin, up to a certain percentage of what you deposited. The deposited collateral stays locked until you repay your loan plus any fees. If you never repay, you lose the collateral.

The reason you might want to do this instead of simply selling your cryptocurrency is that a CDP lets you access liquidity without triggering a taxable sale and without giving up potential future gains on the asset you own. If you believe your Ether will increase in value, you can lock it up, borrow stablecoins to spend today, and then repay the loan later — all while still holding your Ether exposure. The system is trustless because the smart contract holds the collateral and enforces the rules without involving a bank.

CDPs are the mechanism behind protocols like MakerDAO, which created the DAI stablecoin. The risk is that if the value of your collateral drops significantly, the system may automatically liquidate your position — sell your collateral to cover the debt — to protect the integrity of the borrowed tokens. This is why CDPs almost always require depositing more value than you borrow (see Over-Collateralization).

Example: Imagine you own a rare painting worth $10,000. A pawn shop lets you borrow $6,000 in cash, and holds your painting as security. You still own the painting and expect it to be worth $15,000 next year, so you take the loan, spend the cash, and plan to repay it. If the painting’s value suddenly drops below $6,000 and you cannot top up the collateral, the pawn shop sells the painting to recover its money.