Why Liquidation Bots Are a Necessary Evil in DeFi

Liquidation bots are solvency enforcers. They automatically close undercollateralized positions on protocols like Aave and Compound, preventing bad debt from crippling the entire system. Without them, lending pools become insolvent.

The profit motive creates efficiency. Bots compete in a public mempool to execute liquidations first, creating a race that minimizes the time a position is undercollateralized. This is a more reliable incentive than altruism.

This system is a public good with private capture. While the network benefits from stability, the MEV (Maximal Extractable Value) from liquidations is extracted by sophisticated searchers using tools like Flashbots. The protocol's health is a byproduct of profit-seeking.

Evidence: During the 2022 market crash, liquidations on major protocols exceeded $1 billion in a single day. This automated process prevented systemic collapses that would have destroyed user funds.

Liquidation is a circuit breaker for overcollateralized lending. When a borrower's collateral value falls below a protocol's minimum health factor, the position becomes insolvent. Automated liquidators are triggered to repay the debt and seize the collateral at a discount, protecting the protocol's solvency and other users' deposits.

This discount creates an MEV arena. The liquidation discount is pure, risk-free profit for the first bot to execute the transaction. This profit incentive aligns liquidator and protocol interests, but it also spawns a hyper-competitive gas war environment on networks like Ethereum and Arbitrum.

Bots use sophisticated infrastructure to win. Successful liquidators like Liquidity and B.Protocol operate custom mempool watchers, private transaction relays like Flashbots Protect, and high-performance RPC endpoints to achieve sub-second latency and avoid frontrunning.

The competition centralizes risk. The need for speed and capital consolidates liquidation markets. A few dominant players capture most of the value, creating systemic dependencies. This is a trade-off: efficient safety nets require concentrated, professional operators.

Liquidation bots are solvency enforcers. They are the automated counterpart to a bank's margin call, programmatically closing undercollateralized positions to protect lenders on protocols like Aave and Compound. Without this automated enforcement, bad debt accumulates and the system fails.

They provide critical price discovery. Bots competing for liquidation opportunities on platforms like EigenLayer or MakerDAO create a real-time market for risk. This competition determines the true cost of capital and the speed of system correction.

The alternative is centralized failure. Manual or committee-based liquidation, as seen in early DeFi, is too slow and prone to corruption. Automated bots operated by entities like Jump Crypto or Wintermute create a transparent, albeit ruthless, mechanism.

Evidence: During the 2022 market crash, liquidations on Aave and Compound processed billions in undercollateralized debt within minutes, preventing systemic contagion that would have collapsed slower, centralized systems.

Protocol-Controlled Liquidation Systems replace public bots. Protocols like Aave and Compound now operate their own keeper networks, capturing the liquidation fee revenue and ensuring execution reliability. This internalizes a critical system function.

Dutch auction mechanisms and soft liquidations reduce MEV extraction. Euler's gradual price decay and Morpho Blue's soft liquidation via Uniswap V3 pools prevent the binary, zero-sum liquidation events that bots exploit.

Restaking primitives introduce new risks. EigenLayer's slashing for downtime creates a liquidation-like condition, but its centralized operator set and lack of a public mempool may prevent bot-driven cascades seen in DeFi lending.

Evidence: Aave's transition to a GHO stablecoin-centric model with permissioned keepers demonstrates the shift. The protocol now treats liquidations as a core treasury function, not an external market.