Liquidation

Liquidation in DeFi is the forced closure of an undercollateralized position, protecting protocols from bad debt by selling collateral to repay outstanding loans. The mechanics: you deposit ETH worth $150, borrow $100 DAI. ETH price drops, your collateral value falls to $110 while your debt remains $100. Your collateralization ratio breaches the minimum threshold (often 110-150%). A liquidator, typically an automated bot monitoring on-chain positions, repays part of your debt directly to the protocol and receives your collateral at a discount (the liquidation bonus, often 5-15%). This discount incentivizes liquidators to actively monitor and close risky positions. Liquidation is not theft; it's the mechanism keeping DeFi lending solvent and functional. Without it, protocols would accumulate bad debt when collateral values collapse. However, liquidation is costly and stressful for borrowers: you lose your collateral at below-market prices during an already unfavorable market move. Cascade liquidations occur when mass liquidations drive prices lower, triggering more liquidations in a dangerous feedback loop. Protecting against liquidation requires maintaining conservative ratios, monitoring positions (or using automated management tools), and understanding the specific liquidation parameters of each protocol you use.