How liquidations work in DeFi lending

DeFi lending protocols let you borrow crypto without a credit check. The catch is over-collateralisation: you deposit assets worth more than you borrow, and smart contracts enforce the rules automatically.

The key numbers

• **Loan-to-value (LTV).** The share of your collateral's value you can borrow. An LTV limit of 75% means $1,000 of collateral supports up to $750 of debt.
• **Liquidation threshold.** The point at which the position becomes unsafe, usually a little above the maximum LTV.
• **Health factor.** Many protocols combine these into one number. Above 1 is safe; at or below 1 the position can be liquidated.

What a liquidation is

When collateral prices fall or the borrowed asset rises, the health factor drops. Once it crosses the threshold, anyone can repay part of the debt and receive some of your collateral at a discount, called the liquidation bonus. These liquidators are usually automated bots, so it can happen within seconds.

You keep the borrowed funds, but you lose the collateral that was sold plus the bonus paid to the liquidator. In a sharp market fall, many positions are liquidated at once, which can push prices down further.

Oracles matter

Protocols learn prices from oracles. A delayed or manipulated price feed can trigger liquidations that would not happen at the true market price, which is why oracle design is a common topic in DeFi incident reports.

How borrowers reduce the risk

• Borrow well below the maximum LTV.
• Use collateral that is less volatile than the borrowed asset where possible.
• Set alerts and add collateral or repay early when markets move.

Key takeaways

• Liquidation is automatic and fast; there is no margin call phone call.
• The liquidation bonus is a real cost on top of price losses.
• A buffer below the limit is the main protection.