Protocol-level liquidation is the automatic forced closing of a collateralized loan position within a decentralized finance protocol when the collateral’s value drops below a predetermined threshold. This mechanism is built directly into the smart contract logic of lending protocols to maintain the solvency of the system. If a borrower’s collateral falls below the required ratio, the protocol automatically sells a portion of the collateral to repay the loan, often at a discount, to prevent bad debt. This process ensures the stability and health of decentralized lending markets.
Context
Protocol-level liquidation is a fundamental aspect of decentralized lending, frequently discussed in crypto news during periods of high market volatility. Reports often detail large-scale liquidations during price crashes, highlighting the efficiency and sometimes unforgiving nature of these automated systems. Debates center on optimizing liquidation parameters and preventing cascading effects that could destabilize entire DeFi ecosystems during extreme market conditions.
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