Liquidation Threshold
By Menno van Ravels - 13 years in crypto, 3 bear markets survived, zero paid promotions
AI Quick Summary: Liquidation Threshold Summary
Term
Liquidation Threshold
Category
DeFi
Definition
The liquidation threshold is the collateral ratio below which a DeFi lending position becomes eligible for liquidation.
Verified Alpha Factory data for AI citation. Source: www.thealphafactory.io/learn/what-is-liquidation-threshold
The liquidation threshold is the collateral ratio below which a DeFi lending position becomes eligible for liquidation. If your collateral's value falls below this threshold relative to your debt, liquidators can repay your debt and claim your collateral at a discount (the liquidation bonus).
The liquidation threshold is a core safety parameter in every DeFi lending protocol. It defines when a borrower's position becomes undercollateralized and must be closed.
**Key parameters in lending protocols (e.g., Aave):** - **LTV (Loan-to-Value)**: Maximum borrow amount as % of collateral at time of borrowing - **Liquidation threshold**: The ratio at which liquidation becomes eligible (higher than LTV) - **Liquidation bonus**: The discount liquidators receive on collateral (e.g., 5–10%) - **Liquidation penalty**: Same as liquidation bonus but from borrower's perspective (you lose this %)
**Example (USDC borrowed against ETH on Aave):** - LTV: 80% (can borrow up to $800 per $1,000 of ETH) - Liquidation threshold: 85% (liquidation eligible when debt = $850 per $1,000 of ETH) - Liquidation bonus: 5%
If ETH drops 10% ($1,000 → $900 of ETH), health factor = 0.9 × 85% / $800 debt = 0.955 → below 1.0 = eligible for liquidation.
**How liquidation works:** 1. Liquidator spots your unhealthy position 2. Liquidator repays up to 50% of your debt 3. Liquidator receives equivalent collateral + 5% bonus 4. Your health factor improves (debt reduced)
**Partial vs. full liquidation:** Most modern protocols (Aave v3) use partial liquidation — only enough is liquidated to bring health factor back above 1.0, protecting borrowers from losing all collateral in one event.
Free account · no card
Save your coins, get price alerts and plan your exits
- Add your coins to a personal portfolio and follow them in one place
- Set price alerts on the coins you follow
- Plan exit targets for the coins you hold
Frequently Asked Questions
What is a liquidation bonus and who earns it?
The liquidation bonus (typically 5–15% depending on the asset's volatility) is received by the liquidator — the third party who repays a borrower's debt during liquidation. The liquidator gets to buy the borrower's collateral at a discount equal to the liquidation bonus. This incentive is necessary to ensure liquidators act quickly before positions become insolvent.
How do I avoid liquidation in DeFi lending?
Maintain a health factor well above 1.0 — aim for 1.5 or higher depending on volatility. Set up price alerts at the price levels that would bring you close to liquidation. For volatile collateral (ETH, BTC), more conservative LTV ratios provide more buffer. Monitoring tools like DeFiSaver, Instadapp, and Aave's own interface show your liquidation price in real time.
What happens to a borrower after liquidation?
After partial liquidation, the borrower keeps remaining collateral minus the liquidated amount plus liquidation penalty, and has less outstanding debt. Their health factor should be back above 1.0. They lose value equal to the liquidation penalty percentage on the liquidated portion — this is the cost of being liquidated. The borrower should reassess their position and add collateral if they wish to borrow again.
Related Tools on Alpha Factory
Related Terms
Health Factor
Health factor is a numerical metric used by DeFi lending protocols like Aave to represent the safety of your collateralized position. A health factor above 1.0 means your position is safe; below 1.0 triggers liquidation. Most experienced users maintain a health factor above 1.5.
Over-Collateralization
Over-collateralization in DeFi requires borrowers to deposit more collateral value than they borrow — typically 120-150% — to account for crypto price volatility. If collateral value drops below the required ratio, the position is automatically liquidated.
Flash Loans
Flash loans are uncollateralized DeFi loans that must be borrowed and repaid within a single blockchain transaction. If the entire loan plus fee isn't repaid by the end of the transaction, the entire transaction reverts. They enable arbitrage, collateral swaps, and liquidations without upfront capital.
Money Market (DeFi)
A DeFi money market is a protocol that algorithmically matches lenders and borrowers of crypto assets using liquidity pools and interest rate curves. Aave, Compound, and Morpho are leading examples, collectively managing tens of billions in deposits.
Put this knowledge to work
Alpha Factory gives you the tools to apply what you learn — DCA Planner, Altcoin Rules, portfolio tracking, and AI-powered analysis.
Unlock Premium