Risks & Security

Liquidation

Collateral Liquidation

Automatic sale of collateral when loan becomes undercollateralized

Definition

Liquidation occurs when a borrower's collateral value falls below the required threshold, triggering automatic sale of collateral to repay the loan and protect lenders.

Liquidation (Collateral Liquidation) is a risk term used to understand Automatic sale of collateral when loan becomes undercollateralized. In practice, it matters because it affects how users evaluate protocols, compare opportunities, and avoid hidden assumptions.

Example

If your ETH collateral drops in value and your loan becomes undercollateralized, the protocol will liquidate your ETH to repay the loan.

How it works

In practice, the concept shows up like this: If your ETH collateral drops in value and your loan becomes undercollateralized, the protocol will liquidate your ETH to repay the loan.

Why it matters

Liquidation matters because small misunderstandings in DeFi can turn into bad pricing, liquidation, governance, custody, or smart-contract risk. A good mental model helps you compare protocols without relying on marketing language.

What to check

Treat it as a risk term: identify the failure mode, who can be harmed, and what evidence would reduce that risk. The main checks are: Loss of collateral; Liquidation penalties; Price volatility.

Risks to Consider

Loss of collateral
Liquidation penalties
Price volatility

Common Questions

What does Liquidation mean in DeFi?

Liquidation means Automatic sale of collateral when loan becomes undercollateralized. The useful question is not only the definition, but how the mechanism changes risk, return, liquidity, or governance for the user.

How is Liquidation used in practice?

A practical example: If your ETH collateral drops in value and your loan becomes undercollateralized, the protocol will liquidate your ETH to repay the loan.

What should I check before relying on Liquidation?

Check loss of collateral, liquidation penalties, price volatility. Also verify liquidity, oracle assumptions, admin controls, and whether the protocol has been tested during stressed markets.