⚠️ Liquidation: When Collateral Gets Seized
Learn what happens when your loan becomes undercollateralized
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0 / 5 completed⚡ Understanding Liquidations
Liquidation is the automated process of closing under-collateralized loan positions to protect lenders. It's a critical safety mechanism that keeps DeFi lending protocols solvent.
What is Liquidation?
When a borrower's collateral value drops too low relative to their debt, their position becomes "underwater" or "under-collateralized." Liquidators (bots or people) can step in to repay the debt and claim the collateral at a discount, protecting the lending pool.
Critical Mechanism
Without liquidations, lenders would lose money when borrowers default. Liquidations ensure that every loan is always backed by sufficient collateral, maintaining protocol solvency even in volatile markets.
🎮 Interactive: Participant Perspectives
Explore liquidations from different viewpoints:
Borrower (At Risk)
Person whose collateral is being liquidated due to insufficient health factor
"My collateral value dropped below safe levels. If I don't act fast, liquidators will seize my assets."
⚠ Risks
- • Lose 5-15% of collateral to liquidation penalty
- • Position closed automatically
- • No control once HF < 1.0
- • Can lose entire collateral if fully liquidated
✓ Actions
- • Monitor health factor constantly
- • Add more collateral when HF drops
- • Repay debt to reduce risk
- • Set price alerts
When Does Liquidation Happen?
Trigger Condition
Liquidation is triggered when your health factor drops below 1.0. This happens when collateral value decreases or debt increases relative to each other.
Execution
Liquidators (usually bots) constantly monitor all positions. When they detect HF < 1.0, they race to execute the liquidation and earn the liquidation bonus (5-15%).
Real-World Example
Alice deposits 10 ETH ($20,000) as collateral and borrows $10,000 USDC. Health factor: 1.5 (safe).
ETH price crashes to $1,200. Collateral now worth $12,000. Health factor: 0.9 (underwater).
Bot repays $10,000 debt and claims $10,500 worth of ETH (5% bonus). Alice loses 8.75 ETH, keeping only 1.25 ETH.
Protocol protected (lenders repaid). Liquidator profits $500. Alice lost most collateral due to price drop + penalty.
Liquidation by Protocol
| Protocol | Liquidation Threshold | Penalty | Type |
|---|---|---|---|
| Aave | Asset-specific (80-86%) | 5-10% | Partial (up to 50%) |
| Compound | 75-80% | 8% | Up to 100% |
| MakerDAO | Asset-specific (65-85%) | 13% | Full position |
| Venus | 80% | 10% | Partial |
Key Insight
Liquidations are not punitive—they're protective. They ensure lenders always get repaid, even when borrowers can't or won't repay. The penalty incentivizes liquidators to act quickly, protecting the entire protocol from insolvency.