Liquidation Mechanism

Definition ∞ A liquidation mechanism is a protocol feature designed to automatically settle leveraged positions when their collateral value falls below a predetermined threshold. This process aims to prevent cascading losses and protect the solvency of lending protocols or derivative markets. It involves the sale of collateral to cover outstanding debt, thereby minimizing counterparty risk.
Context ∞ The current discussion regarding liquidation mechanisms is heavily influenced by recent market volatility and the cascading liquidations observed in leveraged trading environments. Key areas of debate include the efficiency of automated liquidation processes, the potential for market impact from large-scale liquidations, and the design of more resilient collateralization ratios. Proposals for improving these mechanisms often involve adjustments to trigger points and auction dynamics.