FOLLOW THE MECHANISM
- 1Revalue
Interest and accepted prices change the health metric.
- 2Qualify
The protocol’s boundary allows liquidation.
- 3Repay and seize
Debt decreases while collateral goes to the liquidator.
- 4Assess residual
Remaining assets may or may not cover remaining obligations.
A conceptual sequence. Real implementations can add steps, intermediaries, and conditions.
A threshold activates recovery
A collateralized lending position can become liquidatable when its health metric crosses the protocol’s boundary. In the Aave-style formula used here, health factor is adjusted collateral value divided by debt value; below one indicates eligibility. The adjustment uses liquidation thresholds rather than maximum entry borrowing limits. Liquidation is intended to intervene while collateral still covers debt plus recovery costs. A position can therefore be solvent at current prices and nevertheless eligible for liquidation. These words describe different conditions.
The liquidator supplies repayment assets
A liquidator typically repays some permitted amount of the borrower’s debt and receives collateral, often with a bonus. That bonus is funded from the borrower’s collateral rather than created without cost. The protocol specifies how much debt can be repaid and how collateral is selected. Aave’s rules depend on position size, health and deployment features; this atlas does not present a single universal close factor. Actual liquidation also requires executable transactions and available repayment liquidity.
A price shock can outrun the buffer
Consider illustrative collateral worth 900 and debt of 700 with an 80% threshold. Health is about 1.03. If collateral drops to 850, health falls to about 0.97 while collateral still exceeds debt. If it instead drops abruptly to 600, full recovery of 700 is no longer possible from that collateral alone. The remaining gap is bad debt unless another resource absorbs it. No threshold can guarantee recovery through arbitrarily large or instantaneous price moves.
Oracle and execution are separate inputs
A liquidation decision uses the protocol’s accepted valuation, while the liquidator’s proceeds depend on realizable market prices. Stale or manipulated oracle values, market depth, congestion and fees can make recovery unattractive or unfair. A valid oracle update can also reveal deterioration suddenly after a period of stale data. Liquidations are performed by transactions or protocol mechanisms, not by an abstract automatic safety shield. The demo distinguishes eligibility, collateral shortage and an illustrative recovery exchange so those causal steps remain visible.
MAKE IT CONCRETE
Illustrative bonus accounting
If a liquidator repays 100 debt units and receives collateral valued at 105, debt falls by 100 while collateral falls by 105. The five-unit difference pays the incentive before other costs; it is not free money added to the system.
FAILURE PATHS & COMMON MISREADINGS
Where the model can break
- Liquidatable does not necessarily mean insolvent.
- A liquidation bonus cannot guarantee a profitable or successful recovery.
KEEP EXPLORING