Liquidation Trigger

The Health Factor (HF) is the core metric that determines liquidation risk. It's calculated as (Collateral Value * Collateral Factor) / Borrowed Value. A liquidation trigger activates when the HF falls below a protocol-defined threshold, typically 1.0. For example, if the threshold is 1.1, liquidation begins when the collateral value drops to just 10% above the borrowed value.

The Collateral Factor (or maximum LTV) sets the initial borrowing limit and defines the liquidation buffer. It's the percentage of an asset's value that can be borrowed against.

• A 75% LTV means a $100 deposit allows a $75 loan.
• This creates a 25% liquidation threshold; if the collateral value drops enough to push the LTV above 75%, the trigger activates. More volatile assets have lower LTVs.

Liquidation triggers are entirely dependent on real-time, accurate price feeds from oracles. The trigger compares the oracle-reported collateral value against the debt value. Key considerations:

• Oracle latency can cause delayed triggers.
• Oracle manipulation is a critical attack vector.
• Protocols often use decentralized oracle networks (e.g., Chainlink) for resilience.

To ensure liquidations are executed promptly, protocols offer a liquidation incentive (or bonus). This is a discount (e.g., 5-10%) at which liquidators can purchase the undercollateralized assets. This mechanism:

• Compensates liquidators for gas costs and risk.
• Creates a competitive market for liquidation execution.
• The bonus is typically paid by the borrower, increasing their loss.

The trigger initiates a public, permissionless liquidation event. Any external actor (a liquidator) can call the smart contract function to:

1. Repay part or all of the borrower's debt.
2. Seize the corresponding collateral at a discount. This design ensures the protocol remains solvent without relying on a centralized party, even during high volatility.

To avoid overly punitive liquidations, many protocols use a close factor. This limits the percentage of a borrower's debt that can be liquidated in a single transaction (e.g., 50%). This allows for partial liquidations, giving the borrower a chance to add collateral or repay debt to restore their Health Factor before their entire position is closed.

The most common trigger, where a position's Health Factor (HF) falls below a protocol-defined threshold (e.g., HF < 1.0 on Aave). This factor is calculated as (Collateral Value * Liquidation Threshold) / Borrowed Value. A breach indicates the collateral is insufficient to cover the debt, prompting automatic liquidation.

Used in perpetual futures and margin trading platforms. A position is liquidated when its margin balance falls below the required maintenance margin level. For example, if a trader's equity drops to 0.5% on a Binance Futures position with a 1% maintenance margin, the position is automatically closed.

Liquidation can be triggered by oracle price updates that suddenly worsen a position's health. In volatile markets, a sharp price drop reported by the oracle can instantly push many positions below their liquidation threshold. This can lead to cascading liquidations if liquidators compete to close positions.

A specific threshold derived from the Loan-to-Value ratio, which is Borrowed Value / Collateral Value. Protocols set a maximum LTV for borrowing (e.g., 80% for ETH on Compound). If market movements cause the actual LTV to exceed the liquidation LTV, the position becomes eligible for liquidation.

Used in options protocols and some lending markets. Positions have a fixed expiry date. If not closed or rolled over by expiry, they are automatically liquidated or settled. This is a deterministic trigger based on time, not market price.

While automated by code, the liquidation transaction itself is often initiated by a keeper bot or liquidator. These off-chain actors monitor the blockchain for undercollateralized positions and submit a transaction to trigger the liquidation, earning a liquidation bonus or fee for their service.

The most common trigger is a protocol's Health Factor (HF) falling below 1.0. The HF is calculated as (Collateral Value / Loan Value). When market volatility reduces collateral value or increases loan value, the HF drops. Reaching the liquidation threshold (e.g., HF < 1.0 on Aave) flags the position for immediate liquidation to prevent the loan from becoming insolvent.

Liquidation triggers are activated by real-time oracle price feeds (e.g., Chainlink). These decentralized oracles provide the definitive market price used to calculate a position's collateralization ratio. A sharp price drop in the collateral asset, reported by the oracle, is the primary event that pushes the Health Factor below its safe threshold, triggering the liquidation process.

Protocols create economic incentives for third-party keepers (bots) to monitor and execute liquidations. The trigger includes a liquidation bonus (or penalty) – a discount on the seized collateral granted to the liquidator. This system ensures that triggered liquidations are executed swiftly, with keepers competing to capture the profit, which maintains protocol solvency.

Different protocols implement unique trigger mechanics:

• MakerDAO: Uses a liquidation ratio for each vault type; collateral is auctioned if the collateral-to-debt ratio falls below this level.
• Compound & Aave: Use the Health Factor model with a configurable liquidation threshold per asset.
• Perpetual Futures (dYdX): Triggers based on maintenance margin; positions are liquidated if margin balance falls below this requirement.

Users manage liquidation risk by:

• Monitoring Health Factors in real-time dashboards.
• Adding more collateral to increase the buffer.
• Repaying debt to lower the loan-to-value ratio.
• Using debt rebalancing or stop-loss services that automatically adjust positions before the trigger point is hit.

Once triggered, the process is automatic and punitive:

1. The undercollateralized position is frozen.
2. A portion of the collateral is seized and sold, often at a discount.
3. The debt is repaid in full.
4. Any remaining collateral (minus a liquidation fee) is returned to the borrower. The borrower suffers a significant loss due to the discounted sale.

The primary liquidation trigger is a user's Health Factor (HF) falling below 1.0. This metric is calculated as (Collateral Value * Collateral Factor) / Borrowed Value. When HF < 1, the position is deemed undercollateralized and can be liquidated. This is a solvency safeguard for the protocol, ensuring bad debt is minimized.

Liquidation triggers are vulnerable to oracle attacks. If an attacker can manipulate the price feed used to value collateral (e.g., via a flash loan), they can artificially trigger liquidations on healthy positions or prevent their own from being liquidated. This is a systemic risk requiring robust, decentralized oracle solutions like Chainlink.

During high volatility, a wave of liquidations can create a feedback loop:

• Liquidators sell collateral on the open market.
• This selling pressure drives the collateral price down further.
• This pushes more positions below their liquidation threshold. This cascade can lead to market instability and exacerbate losses for users.

Liquidators are incentivized by a liquidation bonus (or penalty) taken from the liquidated user's collateral. However, if the bonus is too small or market liquidity is low, liquidations may not be executed promptly, allowing bad debt to accumulate. High slippage during execution can also mean the liquidator fails to cover the debt, leaving protocol insolvency risk.

Liquidation transactions are a prime target for Maximal Extractable Value (MEV). Bots can monitor the mempool for pending liquidations and front-run them by submitting their own liquidation transaction with a higher gas fee. This creates a competitive environment that increases network congestion and raises costs for all users, while the original liquidator loses their reward.

Users must maintain a safety margin above the official liquidation threshold. Due to network latency, price volatility, and the public nature of transactions, a position can be liquidated before the user can act. Key risks include:

• Gas Wars: Needing to outbid bots to add collateral.
• Oracle Latency: Stale prices causing unexpected triggers.
• Protocol Parameters: Sudden changes to Loan-to-Value (LTV) ratios or oracle sources.

The specific market price of the collateral asset at which a position becomes eligible for liquidation. It is calculated based on the collateralization ratio and the loan-to-value (LTV) threshold of the protocol. For example, if ETH is used as collateral for a DAI loan with a 150% minimum ratio, the liquidation price is the ETH price where the collateral value drops to 150% of the loan value.

A fee, often expressed as a percentage, charged to a borrower when their position is liquidated. This penalty is deducted from the remaining collateral and serves two purposes:

• Compensates the liquidator for their work and risk.
• Discourages borrowers from operating at dangerously low collateral levels. Penalties typically range from 5% to 15% depending on the protocol and asset.

The discount at which a liquidator can purchase the seized collateral from a liquidated position. For instance, with a 5% bonus, a liquidator repays $100 of debt to receive $105 worth of collateral. This incentive mechanism ensures there is always economic motivation for third parties to liquidate underwater positions, maintaining the protocol's solvency.

A numerical representation of a position's safety, commonly used in lending protocols like Aave and Compound. It is calculated as (Collateral Value * Liquidation Threshold) / Total Borrowed Value. A Health Factor below 1.0 triggers liquidation. Users monitor this metric to gauge their risk level and add collateral or repay debt before reaching the trigger point.

The traditional finance counterpart to a liquidation trigger. A broker demands that an investor deposit additional funds or securities when the value of a margin account falls below the maintenance margin requirement. Unlike automated DeFi liquidations, TradFi margin calls often allow a grace period for the investor to meet the call before assets are forcibly sold.

A feature where a protocol or a smart contract automatically initiates the liquidation process as soon as the trigger condition is met, without requiring a third-party liquidator. This is common in perpetual futures contracts on DEXs. It reduces latency and ensures immediate action, but relies on robust oracle feeds and can lead to liquidation cascades during extreme volatility.