DeFi Liquidation: What It Is, Why It Happens, and How to Avoid It

When you borrow crypto in DeFi liquidation, the automatic process where your collateral is sold to cover a loan that’s fallen too far below its required value. Also known as margin call in traditional finance, it’s not a bug—it’s a built-in safety feature designed to protect lenders from losses. But for borrowers, it’s the moment everything can go wrong in seconds.

DeFi liquidation happens when the value of your collateral drops below the collateral ratio, the minimum amount of assets you must lock up compared to how much you borrow. For example, if you borrow $1,000 worth of ETH but only put up $1,500 in BTC as collateral, and BTC’s price crashes 40%, your collateral might fall to $900. That’s below the required 150% threshold, and the protocol will automatically sell your BTC to repay the loan. You lose your assets, and you still owe nothing—because the system closed your position before you could.

This isn’t just theoretical. In 2022, over $2 billion in collateral was liquidated across major DeFi platforms like Aave and Compound during the Terra collapse. People who didn’t monitor their margin trading, the practice of borrowing funds to increase exposure to an asset, often with high leverage got caught flat-footed. They thought they had room to breathe—until the market moved faster than their phone could refresh.

DeFi protocols don’t hate you. They’re just math. The system doesn’t care if you’re holding for the long term, if you’re waiting for a rebound, or if you’re new. If your loan-to-value ratio breaches the line, the liquidator bot strikes. And those bots? They’re fast. Faster than you. Faster than your broker. They’re coded to act the second the price hits the trigger.

But you’re not powerless. You can avoid liquidation by keeping extra cushion—like holding 200% or 300% collateral instead of the minimum 150%. You can set up price alerts so you know when your position is getting risky. You can even use tools that auto-add collateral when your ratio dips. Some platforms, like MakerDAO, let you top up your collateral manually before liquidation kicks in. Others don’t. Know which one you’re using.

And don’t confuse DeFi protocols, decentralized platforms that let you lend, borrow, or trade crypto without banks or middlemen with banks. Banks give you warnings. DeFi protocols don’t. They don’t call you. They don’t email you. They just execute. Your responsibility is to stay ahead of the curve.

Below, you’ll find real-world examples of how people lost—or saved—thousands during volatile markets. You’ll see breakdowns of platforms where liquidation risk is highest, tools that help you track your exposure, and how to spot the early signs before it’s too late. This isn’t about fear. It’s about control.