Definition
Automated liquidation is a risk-management process in decentralized finance in which smart contracts automatically sell or seize collateral when predefined safety conditions are breached. It is typically triggered when a borrower’s collateral value falls relative to their debt, causing the position’s collateralization ratio to drop below a protocol’s minimum requirement. The process is enforced by code rather than human discretion, ensuring that undercollateralized positions are closed in a predictable and rules-based manner.
This mechanism is central to many lending, margin trading, and derivatives protocols that rely on overcollateralization. By liquidating positions as soon as they become unsafe, automated liquidation helps maintain solvency of the protocol and protects liquidity providers or lenders from bearing excessive losses. The parameters that govern it, such as liquidation thresholds, penalties, and discounts, are usually specified in the protocol’s smart contracts or governance framework.
Context and Usage
Automated liquidation is closely associated with collateralized borrowing, where users lock assets to obtain loans or leverage. When market prices move against a position, the protocol’s smart contracts continuously assess whether the position still satisfies required risk metrics, such as minimum collateral ratios or health factors. If those metrics fall below the configured limits, the position is flagged for liquidation and part or all of the collateral is sold or transferred to repay outstanding obligations.
In practice, automated liquidation defines how risk is distributed between borrowers, lenders, and the protocol itself. It formalizes the conditions under which a borrower’s collateral can be taken and how any liquidation fees or penalties are allocated. Because it is deterministic and transparent, this process shapes user behavior, influencing how conservatively positions are structured and how protocols calibrate their overall risk tolerance.