A collateralized debt position (CDP) is a type of smart contract that allows users to lock up a certain amount of digital assets, usually Ether (ETH), as collateral to borrow against. The term was popularized by MakerDAO and the minting of its stablecoin, Dai, via a CDP.
To open a CDP, a user deposits their ETH into a smart contract on the MakerDAO platform. The smart contract then issues the user a certain amount of DAI, based on the current value of the ETH collateral and the loan-to-value (LTV) ratio of the CDP. The LTV ratio determines the maximum amount of DAI that a user can borrow against their deposited ETH collateral.
As the value of the deposited collateral fluctuates with market conditions, the user must maintain a certain collateralization ratio to avoid having their CDP liquidated. If the value of the collateral falls below the required ratio, the smart contract will automatically liquidate the user's CDP to recover the loan amount and return the remaining collateral to the user. This ensures that the platform remains solvent and that DAI remains stable in value relative to the US dollar.
The collateralized debt position mechanism is a key feature of the MakerDAO platform, allowing users to access liquidity without selling their digital assets. It also enables the creation of a decentralized stablecoin that is backed by a diversified pool of digital assets, providing a more stable and reliable alternative to traditional fiat currencies.