Library · Crypto, word by word · DeFi
What is liquidation in crypto?
Liquidation is the forced sale of a borrower's or trader's collateral when its value no longer covers the loan or position. In DeFi lending, other users repay part of the debt and receive the collateral at a discount; on futures platforms the position is closed.
What it means for you
Liquidation usually costs more than the shortfall: the discount given to the liquidator comes out of your collateral, and it can happen in minutes during a sharp price move. On a lending protocol, watch the health factor; below 1.0 your position can be liquidated.
How it works
A lending position becomes eligible once its health factor drops below 1.0. Nobody at the protocol decides: any account can call the liquidation function, repay some or all of the debt, and receive the borrower's collateral plus a bonus. In one current design the bonus grows the lower the health factor falls, like a Dutch auction. On leveraged futures, when losses eat through the margin, the trader must add margin or the position is closed out. The BIS notes that waves of forced liquidations accompanied sharp price falls.
An example
Say you borrowed 600 against collateral worth 1,000 and its price falls until your health factor is below 1. A liquidator repays 300 of your debt and takes collateral worth 300 plus a 5% bonus, 315 in total. The extra 15 is lost to you on top of the price fall.
Sources: Aave documentation: Liquidations, BIS Quarterly Review: DeFi risks and the decentralisation illusion, CFTC: Understand the Risks of Virtual Currency Trading · checked 4 October 2026
Often confused with
Related words
Educational content, not financial advice. Written by hand and checked against the source named above. Something wrong? Tell us and we reply within two business days.