A liquidation happens when your collateral value drops below the minimum required to support your loan, and the protocol automatically sells your collateral to repay the debt. On Aave, this triggers when your health factor falls below 1.0. On MakerDAO, when your collateralization ratio drops below the minimum (e.g., 150% for ETH). You lose your collateral plus a liquidation penalty (5-13%), and the protocol stays solvent.
What Is a Liquidation (DeFi Lending)?
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The short version
You borrowed $10,000 against $15,000 in ETH collateral. ETH drops 35% and your collateral is now worth $9,750, less than your debt. The protocol does not call you to add more collateral. It immediately sells your ETH to whoever will buy it at a discount, repays your loan from the proceeds, charges you a penalty, and returns whatever scraps are left. This all happens in one transaction, often within seconds of crossing the threshold.
How It Works
How liquidation works on Aave V3: Health Factor = (total collateral in USD x weighted average liquidation threshold) / total debt in USD. When HF drops below 1.0, anyone (liquidation bots) can call the liquidate function. The liquidator repays up to 50% of the borrower debt and receives the corresponding collateral plus a liquidation bonus (5-10% depending on the asset). The borrower keeps the borrowed tokens but loses collateral worth the repaid debt + bonus. Example math: you deposit 5 ETH ($15,000) with liquidation threshold 82.5%. You borrow 10,000 USDC. HF = ($15,000 x 0.825) / $10,000 = 1.24 (safe). ETH drops to $2,450. HF = ($12,250 x 0.825) / $10,000 = 1.01 (barely safe). ETH drops to $2,400. HF = ($12,000 x 0.825) / $10,000 = 0.99. Liquidation triggered. A bot repays 5,000 USDC of your debt and takes ~$5,250 worth of ETH (debt + 5% bonus). Your remaining position: $6,750 ETH collateral, $5,000 USDC debt. You lost $5,250 in ETH but kept the borrowed USDC. How to avoid liquidation: (1) Borrow conservatively (keep HF above 2.0, not just above 1.0). (2) Set up monitoring alerts (tools like DefiSaver, Instadapp trigger automatic collateral top-ups). (3) Keep stablecoins available to repay debt quickly if prices move against you. (4) Use stablecoin-only positions for zero liquidation risk.
Getting partially liquidated on Aave with 5 ETH collateral
You deposited 5 ETH at $3,000 ($15,000 collateral) and borrowed 9,500 USDC. Starting HF: ($15,000 x 0.825) / $9,500 = 1.30. Market crash overnight. ETH drops to $2,300. New collateral value: $11,500. New HF: ($11,500 x 0.825) / $9,500 = 0.998. Below 1.0. A liquidation bot calls liquidate within the same block. It repays 4,750 USDC (50% of debt) and receives 4,750 / $2,300 x 1.05 = ~2.17 ETH ($4,987 including 5% bonus). Your position after liquidation: 2.83 ETH remaining ($6,509 at $2,300), 4,750 USDC debt remaining. HF now: ($6,509 x 0.825) / $4,750 = 1.13 (safe again, but you lost 2.17 ETH permanently). If you had started with HF of 2.0+ (borrowing only $6,188 instead of $9,500), ETH would need to drop to $1,500 before liquidation, a 50% decline instead of 23%.
What People Get Wrong
Liquidation means you lose everything
On Aave, only up to 50% of your debt is repaid per liquidation event (called close factor). You keep the borrowed tokens and whatever collateral remains after the partial liquidation. You lose the liquidated portion plus the bonus, not your entire position. On MakerDAO, the full debt can be covered in one auction, which is more severe.
The protocol calls you before liquidation
There are no warnings, no margin calls, no grace periods. The moment your health factor crosses 1.0, any liquidation bot can execute it. This happens in the same block (12 seconds on Ethereum). If you are sleeping when the price drops, you wake up already liquidated. Automated monitoring (DeFi Saver) is the only protection.
Liquidation only happens during major crashes
Even a 10-15% price drop can trigger liquidation if you borrowed near your maximum LTV. During the normal volatility of crypto (5-10% daily swings are common), positions at high utilization are constantly at risk. Liquidation does not require a crash, just movement beyond your buffer.
Keep Reading
Sources & Further Reading
- Aave Risk Parameters
Official liquidation thresholds and LTV ratios for every Aave asset
- DeFi Saver
Automated collateral management that tops up or repays before liquidation
- DefiLlama Liquidations
Track total liquidatable positions at each price level across DeFi
Questions People Also Ask
- Can I get my liquidated collateral back?
- No. Once liquidated, the collateral is gone (sold to the liquidator at a discount). You keep the borrowed tokens. The only way to recover is to have prevented it in the first place (lower borrow amount, auto-repay tools, or manual collateral top-up before crossing the threshold).
- Who are the liquidators?
- Liquidation bots run by professional MEV searchers and DeFi participants. They monitor all at-risk positions on-chain and compete to execute liquidations (earning the 5-10% bonus). Some run on Flashbots for priority execution. Anyone can run a liquidation bot, and the competition keeps the system healthy by ensuring liquidations happen promptly.
- What is a safe health factor to maintain?
- For volatile collateral (ETH, BTC): keep HF above 2.0 (gives ~50% price buffer before liquidation). For stablecoin collateral (USDC backing DAI borrow): HF above 1.3 is sufficient (stablecoins rarely move more than 5%). The more volatile your collateral, the higher your safety margin should be. Never borrow at maximum LTV.