Liquidation Bot

Bots continuously poll blockchain nodes and mempools to monitor collateralization ratios and funding rates. They track health factors on Aave and Compound, and margin ratios on perpetual DEXs like dYdX. This constant surveillance is the first line of defense, allowing bots to identify undercollateralized positions the instant they become eligible for liquidation.

To win liquidation auctions, bots must submit transactions that are mined first. They employ sophisticated strategies:

• Dynamic Gas Estimation: Calculating optimal gas prices based on network congestion.
• Priority Fee Bidding: Outbidding competitors by attaching higher fees to their transactions.
• Bundle Building: Submitting transactions in bundles via services like Flashbots to avoid public mempool frontrunning.

Before executing, bots perform an on-chain simulation to assess the liquidation's viability. They calculate:

• Liquidation Bonus: The discount (e.g., 5-15%) received on the seized collateral.
• Gas Cost: The expected cost of the transaction.
• Net Profit: Bonus Value - Gas Cost. Bots only proceed if this value is positive and exceeds their minimum profitability threshold, managing MEV (Maximal Extractable Value) capture risk.

Liquidations are executed in a single, atomic transaction to eliminate execution risk. This transaction bundle typically includes:

• Repaying the borrowed debt.
• Seizing the discounted collateral.
• Immediately swapping the seized assets (e.g., via a flash loan or DEX aggregation) to repay the initial loan and realize profit. If any step fails, the entire transaction reverts, protecting the bot's capital.

Advanced bots operate across multiple protocols to capture cross-protocol arbitrage. For example, a position may become liquidatable on Compound before Aave due to slight differences in oracle prices or health factor calculations. Bots monitor these discrepancies to be the first to liquidate wherever the opportunity arises, increasing their total addressable market.

To ensure maximum uptime and reliability, professional bot operations deploy redundant infrastructure:

• Multiple RPC Nodes: Connections to several node providers (Alchemy, Infura, private nodes) to avoid single points of failure.
• Geographic Distribution: Servers in multiple regions to reduce latency.
• Fallback Mechanisms: Automated failover systems that switch providers if latency spikes or errors occur.

A liquidation bot's primary function is to monitor the health factor or collateralization ratio of user positions on DeFi protocols like Aave, Compound, and MakerDAO. When a position falls below the required threshold, the bot automatically submits a transaction to liquidate it, repaying the borrower's debt in exchange for their collateral at a discount, known as the liquidation bonus.

Effective bots require several components:

• Monitoring: Continuously scans the blockchain or uses protocol events for undercollateralized positions.
• Transaction Building: Constructs the precise calldata for the liquidation function call.
• Gas Optimization: Uses techniques like gas bidding and private mempools (e.g., Flashbots) to win liquidation auctions.
• Risk Management: Calculates profitability after gas costs and slippage.

Strategies often involve liquidation cascades, where one liquidation triggers others.

Bots are driven by the liquidation incentive, a discount (e.g., 5-15%) on the seized collateral. This creates a competitive, MEV (Maximal Extractable Value)-intensive environment.

Risks include:

• Gas Wars: High network congestion can make transactions unprofitable.
• Slippage: Price volatility between transaction simulation and execution.
• Smart Contract Risk: Bugs in the bot's own code or the underlying protocol.
• Regulatory Scrutiny: The automated nature may attract legal attention in some jurisdictions.

Liquidation bots are a subset of DeFi MEV. Common examples and tools include:

• Keeper Networks: Like Keep3r Network or Gelato Network, which automate and reward keepers for executing jobs.
• MEV Bots: Many generalized MEV searchers run liquidation strategies.
• Monitoring Dashboards: Services like DeFi Saver or Instadapp offer liquidation protection for users, often powered by similar bot logic.
• Flash Loans: Bots frequently use flash loans from protocols like Balancer or Uniswap to fund large liquidations without upfront capital.

Liquidation bots are critical infrastructure for DeFi lending markets. Their presence ensures:

• System Solvency: Bad debt is quickly cleared, protecting lenders.
• Market Efficiency: Collateral is rapidly recapitalized and returned to the market.
• Price Stability: By enforcing collateral requirements, they mitigate the risk of death spirals during market crashes.

Without efficient bots, protocols would carry more systemic risk, potentially requiring larger safety funds or more conservative risk parameters.

A liquidation bot is an automated program that continuously monitors on-chain lending protocols (like Aave or Compound) for undercollateralized positions. Its primary function is to repay a borrower's debt in exchange for their collateral at a discount, ensuring the protocol remains solvent. This process is essential for risk management, as it protects the protocol and its lenders from bad debt by closing risky positions before they become insolvent.

The bot's operation follows a precise sequence:

• Monitoring: Scans the mempool and blockchain state for positions where the collateralization ratio falls below the liquidation threshold.
• Bidding: When a position is eligible, the bot submits a transaction to repay part or all of the debt.
• Seizure: In return, the bot receives the user's collateral, typically at a liquidation bonus (e.g., 5-10% discount).
• Profit Realization: The bot sells the seized collateral on the open market, aiming to profit from the discount after accounting for gas fees and slippage.

While vital for protocol health, liquidation bots introduce systemic considerations:

• Network Congestion: During market crashes, a "liquidation cascade" can occur, where mass liquidations spike gas prices and congest the network.
• Centralization Risk: The profitability of liquidation is often dominated by a few sophisticated, well-capitalized operators, creating a potential point of failure.
• Oracle Manipulation: Bots rely on price oracles; attacks or delays in price feeds can lead to unfair liquidations or missed opportunities.
• MEV Extraction: Liquidations are a prime source of Maximal Extractable Value (MEV), where bots compete via priority gas auctions, often passing high costs to end-users.

The field is highly competitive, leading to advanced strategies:

• Mempool Sniping: Bots monitor the public mempool for pending transactions that will trigger a liquidation, attempting to front-run them.
• Private Order Flow: Sophisticated operators use services like Flashbots to submit transactions via private relays to avoid public sniping.
• Gas Optimization: Code is optimized for execution speed and gas efficiency to win auctions where profit margins are slim.
• Cross-Protocol Monitoring: Bots often monitor multiple protocols simultaneously to maximize opportunity coverage.

Protocols design specific mechanisms for liquidations that bots must adapt to:

• Fixed Discount (Compound, Aave): A set bonus is offered to the first liquidator.
• Dutch Auction (MakerDAO): The collateral discount starts high and decreases over time in an auction.
• Keeper Networks (Maker's Auction Keepers): A designated network of bots is incentivized to perform liquidations.
• Health Factor: The universal metric bots track, calculated as (Collateral Value) / (Borrowed Value). A health factor below 1.0 triggers liquidation eligibility.

Understanding liquidation bots requires familiarity with adjacent concepts:

• Liquidatable Debt: The total value of loans that have fallen below the safety threshold.
• Liquidation Call: The specific on-chain function invoked to execute a liquidation.
• Close Factor: The maximum percentage of a borrower's debt that can be repaid in a single liquidation transaction.
• Bad Debt: The deficit that occurs if collateral value is insufficient to cover the loan after liquidation, a failure state the bots are designed to prevent.