Liquidation

In lending, liquidation is the forced sale of a borrower's collateral when its value falls below a required threshold. It repays part or all of the outstanding loan and protects lenders from a loss when a borrower cannot cover the debt.

Loans that use collateral require the collateral to stay worth more than the amount borrowed. If the collateral drops in price or the loan grows through accrued interest, the position can cross the threshold set by the lender or the protocol. At that point some of the collateral is sold to bring the loan back within safe limits.

On many on-chain lending protocols this process runs automatically through smart contracts, and outside parties can trigger it once conditions are met. Liquidation is a normal risk-management mechanism, but it can happen quickly during sharp price moves, and borrowers may lose collateral and pay added fees or penalties.