Glossary · L
Liquidation
The automatic closure of a borrower's collateralised position when the collateral value falls below the required ratio. In DeFi lending, smart contracts and liquidation bots execute this without human intervention. Liquidated borrowers typically receive a smaller amount of collateral back after a liquidation penalty is deducted.
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How Liquidation works in practice
Liquidation is the mechanism that keeps a lending protocol solvent. When a position's collateral falls too close to its debt, anyone may repay part of that debt and take collateral at a discount. The discount is the incentive that guarantees someone will act quickly — and it is paid by the borrower.
Worked example
A position holds 30,000 of ETH against 24,000 of debt at an 85% liquidation threshold. ETH falls 10%: collateral is now 27,000, and the debt is 88.9% of it. A liquidator repays 12,000 of the debt and receives 12,600 of ETH — a 5% bonus. The borrower keeps a position, minus that 600.
Figures are illustrative and chosen to be checkable, not live market data.
The mistake that costs people money
Assuming you will have time to add collateral. Liquidation bots watch every block and act within seconds of a position becoming eligible. In a sharp move, the first you know of it is usually that it has already happened.
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Liquidation: common questions
- What is Liquidation?
- The automatic closure of a borrower's collateralised position when the collateral value falls below the required ratio. In DeFi lending, smart contracts and liquidation bots execute this without human intervention. Liquidated borrowers typically receive a smaller amount of collateral back after a liquidation penalty is deducted.
- How does Liquidation work in practice?
- Liquidation is the mechanism that keeps a lending protocol solvent. When a position's collateral falls too close to its debt, anyone may repay part of that debt and take collateral at a discount. The discount is the incentive that guarantees someone will act quickly — and it is paid by the borrower.
- Can you give an example of Liquidation?
- A position holds 30,000 of ETH against 24,000 of debt at an 85% liquidation threshold. ETH falls 10%: collateral is now 27,000, and the debt is 88.9% of it. A liquidator repays 12,000 of the debt and receives 12,600 of ETH — a 5% bonus. The borrower keeps a position, minus that 600.
- What do people get wrong about Liquidation?
- Assuming you will have time to add collateral. Liquidation bots watch every block and act within seconds of a position becoming eligible. In a sharp move, the first you know of it is usually that it has already happened.
- Where can I learn more about Liquidation?
- Our full guide, Is DeFi Safe?, covers Liquidation in depth with worked scenarios and the risks involved. This glossary entry is the short definition.