DeFi
DeFi Liquidation: What It Is and How to Avoid It
In the context of decentralized finance (DeFi), liquidation occurs when the value of a borrower’s collateral falls below the agreed upon threshold. DeFi borrowing typically sees borrowers provide collateral between 1.5 and 3 times the amount borrowed, with the loan typically delivered to the borrower in the form of stablecoins such as USDC, Dai, USDT or others.
However, the collateral provided by borrowers usually comes in the form of crypto tokens like Bitcoin, Ethereum, Polygon and others. Since these assets tend to be very volatile, there is always a risk that their value will fall below the amount required as collateral, even if they were equivalent when the loan was first taken out.
Top DeFi lending platforms like CreatorDAOCompound and Aave differ in their approach to liquidation, with some liquidating a user’s entire collateral and others liquidating only a portion.
Let’s take a look at some of the steps DeFi users can take to avoid the threat of having their collateral liquidated and their loan withdrawn.
Self-liquidation
A simple and straightforward way to avoid being forcibly liquidated by a given lending platform is to simply repay all or part of the loan yourself using funds from the sale of your collateral.
While this scenario is not ideal, it may be the only way to avoid being liquidated for some users and, at the very least, gives the individual control over how they close their loan.
Increase the warranty
DeFi borrowing is based on a concept called loan-to-value (LTV), which measures the amount of collateral provided relative to the value of the loan taken. Current LTVs in the DeFi Loans In the space, borrowers get loans between 50 and 75 percent of the value of the collateral they provide.
If the value of the collateral falls below the agreed ratio, the user is exposed to the risk of liquidation.
Therefore, if the threat of liquidation looms, DeFi users can simply increase the value of their collateral by depositing more cryptocurrency tokens. This will prevent liquidation in the short term, but may not be a viable long-term solution if the value of the collateralized assets continues to decline.
Constantly monitor your LTV ratio
Liquidation can be avoided by exercising vigilance over the status of the LTV ratio of a given loan. There are a host of useful tools and services that send real-time health updates and alerts to a borrower, informing them of the status of their loan. Of course, unless you stay awake 24 hours a day, you might miss the updates and get wiped out anyway.
However, monitoring the LTV of your loan when you can is crucial given the volatility of collateralized assets, and is a simple best practice technique that can minimize the threat of liquidation.
Exercise risk management
The primary use case for most DeFi loans is to fund trading accounts. Therefore, the way an individual approaches their transactions can have a major effect on their loan status. If they lose all their negotiated money, there is a good chance their collateral will be liquidated.
Traders should exercise good risk management by setting stop-losses, diversifying their portfolio and trade direction, using pair trading to mitigate risk, maintaining a trading journal and taking any other measure to ensure that they do not take unnecessary risks. their funds.
Compare the prices
The threat of liquidation can be significantly reduced simply by choosing a loan product with a fairer LTV ratio – one that you won’t struggle to repay even in a market downturn.
While the margins between different LTV ratios on major DeFi platforms like CompoundAave and MakerDAO are slim, there are still options for potential DeFi borrowers.
For example, by applying a lease formula to the DeFi lending process, the Nolus The platform allows you to take out loans with a small deposit, rather than putting up 1.5 times the loan amount as collateral.
Additionally, unlike other DeFi lending platforms, Nolus does not liquidate the entire loan in the event of a payment default or a drop in the LTV ratio. Instead, the platform simply removes the next scheduled loan payment from the collateral until the loan is repaid.
Since Nolus allows up to 3x leverage on its loans, users who otherwise would not have the funds to secure a loan can access substantial DeFi loans without risking significant funds.
Conclusion
There is no way out: liquidation in DeFi is an ever-present risk. That being said, this can be avoided by applying some basic safety principles and doing some research first to find the best loan terms that fit your situation.