CoinucationLiquidation
Liquidation is the forced closing of a leveraged position or loan when the collateral falls below the required threshold.
Liquidation occurs when a borrower's collateral is no longer enough to safely cover what they owe. On an exchange, a leveraged trader's position is closed automatically at the liquidation price. In a DeFi lending protocol, the smart contract allows third parties to repay the loan and seize the collateral, usually at a discount, when the loan-to-value ratio crosses a set limit.
Example in DeFi: a user deposits 1 ETH worth 3,000 dollars and borrows 2,000 USDC. If the protocol's liquidation threshold is 80 percent, the position becomes eligible for liquidation when the ETH is worth 2,500 dollars, because 2,000 divided by 2,500 is 80 percent. A liquidator repays the 2,000 USDC and receives ETH worth more than that as a reward.
Mass liquidations can cascade. Forced selling pushes prices lower, which triggers more liquidations, which pushes prices lower again. Several of the sharpest crypto crashes have been accelerated this way. Keeping leverage low and collateral ratios conservative is the standard defense.