Liquidation
The forced closing of a leveraged position or the seizure and sale of collateral when a borrower's position falls below the required margin or collateralization ratio. In DeFi lending, liquidation occurs automatically via smart contracts when the value of collateral drops below a protocol-defined threshold, protecting lenders from bad debt.
“If you borrow $10,000 USDC against $15,000 of ETH on Aave and ETH drops 40%, your collateral value falls to $9,000 — below the liquidation threshold — and a liquidator repays part of your debt in exchange for your discounted ETH.”
Collateral
Cryptocurrency assets pledged as security for a loan in DeFi protocols. Borrowers deposit collateral that exceeds the loan value (overcollateralization) to protect lenders from default risk. If the collateral's value falls below a certain threshold relative to the loan, it can be automatically liquidated.
Leverage
The use of borrowed capital to increase the size of a trading position beyond what the trader's own funds would allow. Leverage amplifies both gains and losses — a 10x leveraged position earns 10x the profit on favorable moves but also faces 10x the losses and can be fully liquidated by a relatively small adverse price movement.
Lending Protocol
A DeFi protocol that enables users to lend crypto assets to earn interest or borrow assets against deposited collateral, all managed by smart contracts without traditional banks. Interest rates are typically set algorithmically based on the utilization rate (ratio of borrowed to supplied assets) within each lending pool.
Overcollateralization
The practice of depositing collateral worth more than the value of a loan to provide a safety buffer against price volatility. In DeFi, most lending protocols require overcollateralization because there is no credit scoring — the excess collateral protects lenders if the borrower's collateral loses value. Typical ratios range from 110% to 200%+.