Bad debt

In an over-collateralized lending market, every position must hold more collateral than debt. When collateral drops fast due to extreme volatility, illiquidity, network congestion that blocks timely liquidation, or a manipulated oracle, liquidators lack the incentive or the ability to execute. The position ends up with collateral below the debt, and that shortfall is bad debt. It is not a technical standard and has no EIP: it is an on-chain accounting metric.

The protocol usually absorbs that shortfall with a safety module or a reserve fund. If the fund falls short, the loss is spread across depositors or token holders. That is why bad debt close to zero signals that the liquidation system and the risk parameters, the loan-to-value ratio (LTV) and liquidation factors, are working. Accumulating it erodes trust and can trigger deposit outflows.