What Liquidation Is

A liquidation happens when your Loan‑to‑Value (LTV) rises above the protocol’s safety threshold.

This can occur because:

• Your collateral drops in price
• The asset you borrowed rises in price
• Interest accumulates and increases your debt
• Protocol parameters change

When this happens, the protocol automatically sells your collateral to repay your loan.

A Simple Example

You deposit $1,000 of ETH as collateral.
You borrow $600 of USDC (60% LTV).
The liquidation threshold is 75%.

If ETH drops to $800, your LTV becomes:

[ 600 / 800 = 75% ]

You are now at the liquidation point.
If ETH drops further, liquidation triggers.

How Liquidation Works

Liquidation is fully automated:

1. Your LTV exceeds the liquidation threshold
2. A liquidator (bot or user) repays part of your debt
3. The protocol sells a portion of your collateral
4. The liquidator receives a bonus (liquidation penalty)
5. Your position becomes safe again; or is fully closed

This ensures the protocol stays solvent.

Key Terms

• Collateral — the asset you deposit
• Debt — what you borrowed
• LTV — debt divided by collateral value
• Liquidation threshold — the LTV at which liquidation begins
• Liquidation penalty — fee taken from your collateral

Understanding these terms is essential for safe borrowing.

Why Liquidation Happens

Liquidation protects the protocol and lenders from:

• Borrowers defaulting
• Collateral becoming insufficient
• Market crashes
• Price manipulation

Without liquidation, lending markets would collapse during volatility.

What You Lose in a Liquidation

When liquidation occurs, you lose:

• A portion of your collateral
• A liquidation penalty (often 5–15%)
• Potential upside if the collateral rebounds
• Gas fees (in some cases)

Liquidation is costly and should be avoided whenever possible.

How to Avoid Liquidation

Borrowers can reduce risk by:

• Keeping LTV well below the threshold
• Using stablecoins as collateral
• Monitoring markets during volatility
• Setting up alerts for price drops
• Adding collateral when needed
• Repaying part of the loan early

Risk management is everything in DeFiDeFiDeFi stands for Decentralized Finance. It refers to a collection of applications and platforms built on blockchain that allow people to transact without banks.Keep learning.

Types of Liquidation Models

Different protocols use different liquidation mechanisms:

• Partial liquidation — only part of your position is liquidated
• Full liquidation — entire position is closed
• Auction‑based liquidation — used by MakerDAO
• Dutch auctions — price decreases until filled
• Keeper‑based systems — bots compete to liquidate

Each model balances fairness, efficiency, and protocol safety.

Liquidation vs Margin Call

DeFi has no margin calls; liquidation is immediate.