Decentralized Finance (DeFi) promises to be a new contender for a radically new financial system. Its foundations are censorship-resistant, non-custodial, and transparent financial protocols. Securing these protocols is achieved by combining cryptographic primitives with economic incentives instead of relying on trusted intermediaries. In DeFi, financial collateral is the central incentive measure providing repercussions against "misbehaving” agents. However, requiring collateral introduces security and efficiency concerns. (i) Securing DeFi protocols using price-volatile and complex assets requires careful risk management. (ii) Efficiency of capital
is diminished since locking assets is an opportunity cost and restricts access to DeFi to agents with sufficient funds. We tackle these issues by developing new protocols to optimize collateral requirements in existing DeFi protocols safely. Our contributions are threefold. First, we provide a risk-based classification of collateral applied in DeFi protocols. Specifically, the classification serves as the starting point to develop a model capturing the security property of financial collateral with unique risks in DeFi. Second, we present two protocols that can be integrated into existing DeFi protocols. Promise transforms suitable DeFi protocols into a subscription mechanism lowering the initial capital locking requirements thus tackling the capital efficiency of collateral. Balance is a protocol to reduce collateral in DeFi protocols safely. Balance is similar to a credit scoring system where “well-behaving” agents enjoy a lowered collateral. As such, Balance can be used both to tailor security of protocols by required per-agent collateral requirements instead of per-protocol requirements and, at the same time, increase capital efficiency of collateral. We demonstrate the practical applicability of Promise and Balance by decreasing collateral in the XCLAIM cross-chain communication protocol by up to 10% under conservative assumptions. Third, we discuss the practical security of financial collateral. We outline new types of attacks on DeFi protocols secured by collateral through trustless coordination of rational agents and so-called flash loans with the example of the popular Maker protocol. We conclude by noting the perils of constructing collateralized DeFi protocols and outlining strands of future work to increase their security and efficiency.