On-chain liquidation is the automatic process, executed by smart contracts on a blockchain, where collateral from a loan is sold to cover the outstanding debt when its value falls below a predetermined threshold. This mechanism is transparent and permissionless, operating according to predefined rules without the need for intermediaries. It ensures the solvency of decentralized lending protocols by automatically adjusting positions in volatile markets.
Context
On-chain liquidations are a frequent subject in DeFi news, particularly during periods of high market volatility, as they highlight the automated risk management of decentralized lending platforms. The efficiency and fairness of these liquidations are continuously debated, with discussions often centering on oracle reliability, gas fees, and the potential for liquidation cascades. Understanding this process is crucial for participants in decentralized lending and borrowing markets.
The exploitation of thin liquidity and high leverage on perpetual DEXs creates systemic risk, allowing market manipulation to trigger catastrophic liquidations.
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