Liquidation Threshold

A liquidation threshold is a parameter in a DeFi lending protocol that determines when a borrowing position becomes eligible for forced liquidation or partial liquidation. It is designed to protect lenders and maintain sufficient collateralization throughout the lending market.

A borrower position depends on the value of its collateral and outstanding debt. When collateral falls in value, the safety margin decreases. Once the relevant threshold is reached, liquidators may be allowed to repay some or all of the debt in exchange for collateral.

The threshold is determined by protocol risk parameters and can differ between assets. More volatile or less liquid collateral can require more conservative parameters because its market value can change rapidly.

The protocol normally relies on a price oracle to determine the current value of collateral. An inaccurate or manipulated price can therefore cause incorrect risk assessments and potentially harmful liquidations.

A liquidation threshold should not be treated as a guaranteed point at which the borrower will have enough time to manually close the position. During rapid market movements, network congestion, or liquidity shortages, the position can change quickly.

Borrowers can reduce liquidation risk by maintaining a larger collateral buffer, repaying debt, or monitoring the position as market conditions change. The exact mechanics and penalties depend on the lending protocol.