What is liquidation in crypto lending?
Liquidation lets debt be repaid using a borrower's collateral when a lending position crosses its risk limit.
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GlossaryLiquidation is how a lending system deals with a loan that no longer has enough backing under its rules. The borrower can lose pledged assets even if they intended to keep them.
Imagine an asset’s price falling while the loan against it stays the same. Once the position crosses the required safety limit, it can become eligible for liquidation. This is a hypothetical example; each market sets its own parameters.
A little more technical
In Aave’s general explanation, a liquidator repays debt and receives collateral, usually with a bonus. This is not necessarily an ordinary market sale. The exact amount and conditions depend on the market.
Common misunderstanding
Liquidation does not need to wait until the collateral is worth zero. A system requires a cushion before that point.
Related concept: collateral. Source: Aave’s liquidation guide.