You should enable PointtoPoint Protocol (PPP) as the encapsulation protocol for the link and Challenge Handshake Authentication Protocol (CHAP) as the authentication protocol for the link by issuing the following command sequence:
Router1(config)#interface serial 1 Router1(config-if)#encapsulation ppp Router1(config-if)#ppp authentication chap


PPP is a wide area network (WAN) protocol used on point-to-point serial links. PPP supports both synchronous and asynchronous communications. HighLevel Data Link Control (HDLC) is another WAN protocol that can be used on pointtopoint serial links, but HDLC supports only synchronous communications. Unlike PPP, HDLC does not support authentication. On Cisco routers, HDLC is the default serial interface encapsulation protocol.

PPP supports two types of authentication mechanisms: Password Authentication Protocol (PAP) and CHAP. When PAP is used, the user name and password of the originating router are sent over the link in plain text. By contrast, when CHAP is used, a hash of the user name and password combination, as well as a random number, is sent to the destination router? the user name and password are not sent across the link. Thus CHAP is more secure than PAP for authentication.