Liquidation
The forced closing of a leveraged trade or collateralized loan when its value falls below the required safety threshold.
Liquidation is the process of automatically closing a position or selling collateral when a trader or borrower can no longer meet the required margin or collateral ratio. In DeFi, it commonly happens in lending protocols and perpetual futures platforms. If the value of deposited collateral drops too far, or a leveraged position moves against the trader, the protocol may liquidate part or all of the position to repay debt and protect the system from losses.
It matters because liquidation is a core risk of borrowing and leveraged trading. For example, if someone deposits ETH as collateral to borrow a stablecoin and ETH’s price falls sharply, their loan may become undercollateralized. The protocol can sell some ETH, often with a liquidation penalty, to cover the borrowed amount. This is similar to a margin call in traditional finance, but in DeFi it is usually handled by smart contracts and third-party liquidators rather than a broker.
Other terms in DeFi
AMM
An automated market maker is a DeFi protocol that uses liquidity pools and algorithms to price and swap crypto assets without a traditional order book.
Aggregator
A DeFi service that searches multiple protocols to find better prices, routes, or yields for a user’s transaction.
DEX
A decentralized exchange is a crypto marketplace where users trade directly from their wallets using smart contracts instead of a central intermediary.
DeFi
A blockchain-based financial ecosystem that lets people lend, borrow, trade, and earn yield without traditional banks or brokers.