Esoteric
Liquidations
The backstop that keeps lending pools solvent: when health factor drops below 1, keepers seize collateral at a discount.
TradFi →Margin call + forced position close-out
Prerequisites
01 · Concept — what problem does it solve?
Over-collateralization only works if someone actually closes positions before they go underwater. is that enforcement: when a borrower's falls below 1, anyone may repay part of the debt and seize the borrower's collateral at a discount. The discount (the ) is the bounty that makes a competitive market of bots — keepers — race to do the protocol's risk management for free.
02 · Mechanics
- Trigger: health factor below 1 — collateral value × no longer covers the debt.
- : how much of the debt a single liquidation may repay. Aave v3 allows up to 100% when health factor is below 0.95 (raised from the old 50% cap) so deeply unhealthy positions clear in one shot.
- Liquidation bonus: the liquidator repays debt and receives collateral worth slightly more (e.g. +5–10%). That is their profit and the borrower's penalty.
- Dutch-auction / soft liquidations: newer designs (Euler, crvUSD) ramp the discount from near zero upward, or de-risk continuously, minimizing the penalty instead of charging a fixed bonus.
- Keepers are actors: liquidations are some of the most contested MEV on chain; bots monitor every position and bid to win the bounty.
03 · Formulas
// liquidation condition
HF = Σ(collateralᵢ · priceᵢ · liqThresholdᵢ) / Σ debtⱼ < 1
// collateral seized for repaying `repaid` of debt
seized = repaid · (1 + liquidationBonus) / collateralPrice
// max repayable in one call
repaid ≤ debt · closeFactor
04 · Edge cases & risks
- Black Thursday (Mar 2020) — ETH crashed, gas spiked, and MakerDAO keepers stalled; some auctions cleared at $0, leaving the system with bad debt and forcing an MKR mint to recapitalize.
- Liquidation cascades — forced collateral sales push the price down, which liquidates more positions, which sells more collateral. Thin liquidity turns a dip into a spiral.
- Keeper absence is chain-dependent — a liquidation only fires if it pays. A small position whose bonus cannot cover L1 gas (dollars) may sit unliquidated and rot into bad debt the pool absorbs — while the same position clears instantly on an L2 where gas is cents. "Health factor below 1" guarantees a liquidation only where a keeper profits.
- latency — liquidations fire on the oracle price; a lagging feed liquidates too late (bad debt) or a manipulated one liquidates healthy users.
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