// GLOSSARY -- DEFI

What is Liquidation?

1 min read Updated

Liquidation in DeFi is the automatic process of selling a borrower's collateral when their loan-to-value ratio exceeds the protocol's threshold — protecting lenders from bad debt.

WHY IT MATTERS

Liquidation is DeFi's enforcement mechanism. When collateral value drops below the required ratio, anyone can trigger liquidation — repaying part of the debt and claiming discounted collateral as profit. This keeps the protocol solvent.

Liquidation bots constantly monitor positions across lending protocols, competing to liquidate unhealthy positions. The liquidation penalty (typically 5-15%) incentivizes this activity and penalizes overleveraged borrowers.

Cascading liquidations during market crashes can amplify price drops: liquidation sells collateral → price drops further → triggers more liquidations. This positive feedback loop is a systemic risk in DeFi.

FREQUENTLY ASKED QUESTIONS

Can I prevent liquidation?
Monitor your LTV, set alerts, maintain healthy collateral ratios, and be ready to add collateral or repay debt during market drops. Some protocols offer protection mechanisms.
Who performs liquidations?
Automated bots (liquidators) that monitor on-chain positions. Anyone can be a liquidator — it's permissionless. The liquidation penalty provides the profit incentive.
What is a liquidation cascade?
When multiple positions are liquidated simultaneously, the collateral selling pressure drives prices down further, triggering more liquidations. This amplification effect can cause flash crashes.

FURTHER READING

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