DeFi Liquidation: What It Is, Why It Happens, and How to Avoid It

When you borrow crypto in DeFi liquidation, the process where a decentralized finance protocol automatically sells your collateral to cover a loan that’s become undercollateralized. It’s not a glitch—it’s a built-in safety feature. Also known as margin call in DeFi, it kicks in when the value of your deposited assets drops too far below the loan amount. This isn’t just for beginners; even experienced traders get caught off guard when markets swing hard.

DeFi liquidation happens because protocols like Aave, Compound, and dYdX let you borrow against your crypto holdings—but they need to protect lenders. If you deposit $10,000 in ETH and borrow $7,000 in USDC, you’re safe as long as ETH stays above a certain price. But if ETH crashes 40%, your collateral might drop to $6,000 while your debt stays at $7,000. That’s when the liquidation threshold, the price level at which a protocol triggers automatic collateral sale to prevent default kicks in. Most platforms set this between 80% and 85% loan-to-value. Once you hit it, bots jump in and sell your assets—often at a discount—to repay the loan. You lose your position, and sometimes, you still owe money.

This isn’t just about bad timing. Many people don’t realize how fast prices can move in DeFi. A 10% drop in a token can trigger liquidation if you’re leveraged 5x or more. That’s why collateral, the crypto asset you lock up to secure a loan in decentralized lending platforms needs to be stable or highly liquid. Using volatile tokens like meme coins as collateral is like playing Russian roulette with your funds. Even ETH and BTC can get crushed in a market panic. The smart move? Keep your loan-to-value ratio low, use stablecoins as collateral when possible, and always monitor your health factor—the metric that tells you how close you are to being liquidated.

Some traders use liquidation as a tool. They know when to add more collateral before the threshold hits. Others set alerts or use automated tools to rebalance positions. But most losses come from ignoring the signs until it’s too late. You don’t need fancy strategies—just awareness. If you’re borrowing in DeFi, you’re already playing with leverage. And leverage cuts both ways. The same system that lets you amplify gains can erase your account in minutes if you’re not careful.

Below, you’ll find real-world breakdowns of platforms like dYdX, tools that track liquidation risks, and deep dives into tokens that have triggered mass liquidations. You’ll see what went wrong for people who lost everything—and how others avoided the same fate. No fluff. No hype. Just what actually happens when the market turns, and how to protect yourself before it’s too late.