Bad Debt
Loans a protocol can no longer recover because collateral fell faster than liquidations could execute — DeFi's insolvency.
Bad debt arises when a borrower’s collateral becomes worth less than their loan and liquidation fails to cover the shortfall — usually because prices gapped down faster than keepers could act, or liquidity vanished mid-crash. The protocol is left holding an unrecoverable loss that, if large enough, makes depositors unable to fully withdraw.
Bad debt is the DeFi equivalent of a bank insolvency, and it’s why robust protocols hold an insurance fund and conservative thresholds. Notable episodes followed sharp crashes and oracle manipulations. When assessing a lending protocol, its history of (and buffers against) bad debt matters more than its headline yields.