Liquidation Call

A liquidation call is a critical risk-management function in overcollateralized lending protocols like Aave, Compound, and MakerDAO. It occurs automatically when a user's health factor or collateralization ratio drops below a predefined safe level (e.g., 1.0). This happens because the value of the borrowed assets (debt) has risen relative to the value of the posted collateral, often due to market volatility. The primary purpose is to protect the protocol and its lenders from bad debt by ensuring loans are always sufficiently backed.

The process is executed by liquidators—bots or users who repay a portion of the undercollateralized debt in exchange for the borrower's collateral at a discounted rate. This discount, known as the liquidation penalty or bonus, incentivizes third parties to participate in the process swiftly. For example, a protocol may allow a liquidator to repay $100 of a borrower's debt to seize $105 worth of their collateral, profiting from the 5% discount. The specific parameters—such as the liquidation threshold, penalty, and the maximum amount that can be liquidated in a single transaction—are set by each protocol's governance.

For borrowers, a liquidation call results in a loss of a portion of their collateral and the payment of the penalty, effectively closing part of their leveraged position at a loss. To avoid liquidation, users can add more collateral or repay part of their debt to improve their health factor. This mechanism is fundamental to maintaining the solvency of DeFi lending markets without relying on centralized intermediaries, though it introduces significant liquidation risk for highly leveraged positions during periods of extreme market stress or network congestion.

A liquidation call is an automated process in decentralized finance (DeFi) protocols that is triggered when a borrower's collateral value falls below a predefined liquidation threshold, forcing the sale or seizure of their assets to repay the outstanding loan and protect lenders. This mechanism is a critical risk-management feature for overcollateralized lending platforms like Aave and Compound, ensuring the solvency of the lending pool. The call is executed by external actors known as liquidators, who are incentivized with a liquidation bonus for closing the risky position.

The process is governed by a user's Health Factor, a numerical representation of their loan's safety. This factor is calculated as (Total Collateral Value * Liquidation Threshold) / Total Borrowed Value. When this value drops to or below 1.0, the position becomes eligible for liquidation. Protocols often set the actual call threshold slightly higher (e.g., 1.1) to provide a buffer. Monitoring this factor in real-time is essential for borrowers to avoid involuntary closure of their positions due to market volatility.

Once triggered, the liquidation call allows a liquidator to repay a portion or all of the borrower's outstanding debt using the protocol's native stablecoin. In return, the liquidator can seize a corresponding amount of the borrower's collateral at a discounted rate, which constitutes their profit. For example, a liquidator might repay $100 of a user's debt to receive $105 worth of the user's ETH collateral—a 5% bonus. This auction-like mechanism ensures bad debt is quickly resolved, keeping the protocol's books balanced.

The technical execution varies by protocol. Some use a fixed percentage discount model, while others employ a Dutch auction where the discount decreases over time. The call is permissionless, meaning any user with the necessary capital can act as a liquidator, creating a competitive market for resolving insolvencies. This design aligns economic incentives, as liquidators are financially motivated to maintain the protocol's health, which in turn secures all lenders' funds.

For borrowers, a liquidation call results in significant losses, as assets are sold at a discount during potentially unfavorable market conditions. Strategies to avoid this include using stablecoins as collateral, maintaining a high Health Factor through overcollateralization, and utilizing debt monitoring tools or liquidation protection services. Understanding this mechanic is fundamental to assessing the risks and responsibilities of participating in DeFi lending markets.

A liquidation call is a critical risk-management mechanism in decentralized finance (DeFi) lending protocols, triggered automatically when a borrower's collateral value falls below a required minimum threshold, known as the liquidation ratio. This event initiates a process where a portion of the borrower's collateral is forcibly sold to repay their outstanding debt, protecting the protocol and its lenders from losses. The primary actors responsible for detecting these conditions and executing the liquidation are keeper bots—specialized, automated software agents that monitor blockchain state and submit transactions for profit.

Keeper bots operate by continuously scanning the blockchain for undercollateralized positions. When a position's health factor drops below 1.0 (or a similar protocol-specific threshold), it becomes eligible for liquidation. The first keeper to successfully submit a liquidation transaction earns a liquidation bonus or fee, typically a percentage of the collateral seized. This creates a competitive, permissionless marketplace for keepers, ensuring liquidations are executed swiftly and efficiently without relying on a centralized entity. Their role is essential for maintaining the overall solvency and stability of the lending pool.

The technical execution involves the keeper bot calling a specific smart contract function, such as liquidate() or liquidatePosition(). The contract then calculates the exact amount of debt to be repaid and the corresponding collateral to be seized, applying any penalties or bonuses. This process often occurs via a public liquidation auction or a fixed-discount sale. By automating this enforcement, keeper bots solve the oracle problem of who acts when a position becomes risky, ensuring the protocol's rules are enforced trustlessly and in real-time, which is fundamental to DeFi's non-custodial ethos.

Running a profitable keeper operation requires significant technical infrastructure, including low-latency blockchain node connections, efficient transaction bundling to minimize gas costs, and sophisticated risk models to calculate potential profit margins after fees. Major protocols like MakerDAO, Aave, and Compound all rely on this ecosystem of keepers. The economic incentives must be carefully calibrated by protocol designers: if the bonus is too low, keepers may not act, risking protocol insolvency; if it is too high, it can lead to overly aggressive liquidation and user dissatisfaction.

In summary, keeper bots are the autonomous enforcers of DeFi's collateralized debt contracts. Their continuous, profit-driven monitoring and execution of liquidation calls are what allow these permissionless systems to manage counterparty risk without intermediaries. This creates a robust, self-regulating financial primitive where the security of lenders' funds is mechanically enforced by open-market incentives and code.

A liquidation call is a function invoked when a borrower's collateralization ratio falls below a predefined liquidation threshold, initiating the forced sale of their collateral to repay their debt. The following pseudocode outlines the typical sequence of checks and state changes. It begins by verifying the borrower's current health factor, ensuring the account is eligible for liquidation, and then calculates the precise amount of debt to be repaid and collateral to be seized, often offering a liquidation bonus to the liquidator as an incentive.

The core logic involves fetching the user's debt and collateral balances, then computing the health factor. If this value is below 1.0 (or the protocol's specific threshold), the call proceeds. The function then determines the liquidation amount, which is often capped at a percentage of the user's debt to prevent overly punitive liquidations. A critical step is the transfer of the debtAsset from the liquidator to the protocol to cover the debt, followed by the transfer of the collateralAsset from the borrower to the liquidator, discounted by the liquidation bonus.

Key Pseudocode Steps

1. Check Health Factor: if (healthFactor < 1.0) revert("Healthy account");
2. Calculate Max Liquidation: maxLiquidation = min(userDebt, collateralValue * maxLTV);
3. Execute Asset Swaps: Transfer debt tokens from liquidator to protocol, burn the borrower's debt, and send collateral tokens to liquidator.
4. Update State: Recalculate and store the borrower's new health factor after the liquidation. This step is crucial to prevent the same position from being liquidated multiple times in the same block.

In practice, protocols like Aave or Compound implement variations, such as using a liquidation close factor to limit the size of a single liquidation or employing price oracles within the health factor calculation. The pseudocode abstracts away gas optimizations and specific token standards (e.g., ERC-20 transferFrom), but captures the essential economic and state-machine logic that ensures protocol solvency by automatically enforcing collateral requirements.