Overview
Liquidation is the forced sale of collateral when a borrowing position falls below its required collateralization ratio. It protects lenders by ensuring loans remain over-collateralized. Third parties can trigger liquidations and earn a bonus.
How It Works
When the value of collateral drops relative to the loan, a position becomes undercollateralized. Liquidators repay part or all of the loan and take the collateral, often with a discount. The process is automatic and permissionless, keeping pools solvent.
Why It Matters
Liquidation is the safety valve of DeFi lending and stablecoins. Without it, bad debt would accumulate and break the protocol. Understanding liquidation thresholds and price feeds is essential for anyone borrowing or providing liquidity.
Related Concepts
Liquidation depends on Collateral, Loan-to-Value, and Oracles for accurate pricing. It is a key risk in Lending and Crypto-Backed Stablecoins.