Definition
In cryptocurrency markets, liquidation occurs when a leveraged trading position or collateralized loan is forcibly closed because the trader’s collateral has fallen below the required maintenance margin. For DeFi lending protocols (Aave, Compound, MakerDAO), liquidation happens when a borrower’s collateral-to-debt ratio drops below the protocol’s liquidation threshold — triggered by falling collateral prices or rising debt. For centralized exchange perpetual futures, liquidation occurs when a trader’s margin balance is exhausted by losses. Liquidations are a critical market mechanism: they prevent bad debt from accumulating in lending protocols and ensure exchanges don’t absorb trader losses.
How Liquidation Works in DeFi Lending
“` Initial position: Deposit: 1 ETH ($3,000) as collateral Borrow: $1,500 USDC (50% LTV) Liquidation threshold: 80% LTV
Scenario: ETH price falls to $1,800 Current LTV = $1,500 / $1,800 = 83.3% → ABOVE 80% threshold → Position is liquidatable!
Liquidation process: Liquidator repays $750 USDC (50% of debt) Liquidator receives $750 + 5% bonus = $787.50 worth of ETH Protocol closes partial position Borrower keeps remaining collateral minus liquidation penalty “`
DeFi Liquidation Parameters (2024–2025)
| Protocol | Asset | LTV Limit | Liquidation Threshold | Liquidation Penalty |
| Aave v3 (ETH) | ETH | 75% | 80% | 5% |
| Aave v3 | WBTC | 73% | 78% | 5–10% |
| Compound v3 | ETH | 82% | 85% | 5% |
| MakerDAO | ETH | 66.6% | 66.6% | 13% |
| Venus (BNB Chain) | BNB | 60% | 70% | 10% |
Cascade Liquidations
Liquidations can cascade in falling markets:
“` Price falls → Position A liquidated → Sells collateral → Price falls further ↓ Position B liquidated → More selling ↓ Position C liquidated → Deeper crash
March 2020: Bitcoin -50% in 24 hours triggered $1B+ in cascade liquidations May 2021: Crypto market -30% → $8B+ liquidated in 24 hours November 2022: FTX collapse → $700M+ in leveraged longs liquidated “`
Avoiding Liquidation
| Strategy | Detail |
| Maintain healthy LTV | Keep borrow ratio well below liquidation threshold |
| Set price alerts | Monitor collateral prices in real-time |
| Add collateral proactively | Deposit more if price approaches threshold |
| Partial repayment | Repay some debt to reduce LTV ratio |
| Conservative leverage | 2–3× leverage vs. protocol maximum |
FAQ
Q: What happens to my remaining funds after liquidation?
In DeFi, you keep remaining collateral minus the liquidation penalty. If you deposited $10,000 ETH and borrowed $5,000 USDC, a partial liquidation might close $2,500 of debt by selling $2,625 of your ETH — you keep the rest. Your net loss is the liquidation penalty (5–13%).
Q: Who are liquidators?
Professional bots (or individuals) monitor lending protocols for undercollateralized positions. When a position crosses the threshold, they compete (via MEV bots) to repay the debt first and claim the liquidation bonus. This arbitrage profit incentivizes the liquidation mechanism to function automatically.
Q: Are perpetual future liquidations different?
In perps, liquidation is faster and more aggressive. When margin balance = maintenance margin, the position is forcibly closed at market. High leverage (50–100×) can result in complete margin loss within minutes on a small price move.
UPay Tip: The safest DeFi borrowing practice is keeping your health factor well above 1.5 (Aave shows this metric) and setting alerts at two price levels: one to warn you, one to prompt immediate action. Liquidation penalties of 5–13% are pure losses on top of your position’s paper loss — the real cost of being liquidated is almost always worse than the loss you’re trying to avoid.
Disclaimer: This content is for educational purposes only and does not constitute financial advice.
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