In the field of decentralized finance (DeFi), one of the core risk control measures of lending protocols is the liquidation mechanism. As a leading lending protocol, Aave ensures the stability and fund security of the platform through an automated and efficient liquidation system. This article will delve into Aave's liquidation mechanism, covering its triggering conditions, process design, roles of participants, and incentive measures.

What is Liquidation?

Liquidation refers to the process where the system automatically triggers a forced repayment when the value of a borrower's collateral is insufficient to cover the debt. Its core purpose is to prevent the risk of insolvency due to a sharp drop in collateral value or excessive accumulation of debt.

In Aave, liquidation is triggered based on two key parameters:

• Collateral Ratio: The ratio of the total value of collateral to the value of the debt.

• Liquidation Threshold: The minimum collateral ratio threshold preset by the system. When the collateral ratio falls below this threshold, the loan is considered "unhealthy," triggering liquidation.

For example, if the liquidation threshold for a certain collateral asset is 75%, liquidation will be automatically initiated when the value of the collateral falls below 75% of the debt value.

Note: Parameters such as liquidation thresholds and discount rates may vary with protocol version updates. Please refer to the official Aave documentation for the most accurate information.

When Does a Loan Become "Unhealthy"?

The following situations may lead to a deterioration in the health status of a loan:

• Decline in Collateral Asset Prices: For example, the price of the ETH pledged by the user plummets by 30%.

• Increase in Debt Size: For floating-rate loans, interest accumulation due to market fluctuations leads to an increase in the value of the debt.

• Insufficient Borrower's Repayment Capacity: The borrower fails to repay interest or principal in a timely manner.

Aave dynamically assesses the risk status of each loan by continuously monitoring the collateral ratio in real-time, combined with price data provided by oracles.

Core Design of Aave's Liquidation Mechanism

Health Factor

Aave introduces the Health Factor (HF) to quantify loan risk, with the calculation formula as follows:

HF = (Total value of collateral × Liquidation threshold) / Total value of debt

• HF > 1: The loan is safe, with sufficient collateral.

• HF ≤ 1: Insufficient collateral, triggering liquidation.

Note: Parameters such as liquidation thresholds and discount rates may vary with protocol version updates. Please refer to the official Aave documentation for the most accurate information.

Liquidation Process

Aave's liquidation process is fully automated, with the following specific steps:

• Risk Detection: The system continuously calculates the HF of all loans in real-time, with oracles constantly updating asset prices.

• Trigger Liquidation: When HF ≤ 1, the loan enters the liquidation queue.

• Liquidator Participation: Third-party liquidators can compete to repay the debt in exchange for purchasing the collateral at a discounted price.

• Debt Repayment: The liquidator repays part or all of the debt (up to a maximum of 50% of the debt) and receives the corresponding proportion of collateral (calculated at a discounted price).

• Remaining Processing: If the collateral is not fully liquidated, the borrower can still replenish the collateral or repay the loan to restore the HF.

Liquidation Penalties and Incentives

• Borrower Penalties: Borrowers who are liquidated must pay a liquidation penalty (usually 5 - 10% of the debt), which is credited to the protocol treasury or distributed to liquidity providers.

• Liquidator Incentives: Liquidators can purchase collateral at a discounted price (e.g., 95% of the market price), with the difference serving as a reward. For example, repaying $100 of debt can yield collateral worth $105 (a 5% discount).

Specific Liquidation Example

Initial State:

• Collateral: 10 ETH ($2000/ETH = $20,000)

• Loan: 12,000 USDC

• Liquidation Threshold: 80%

• Health Factor = (20,000 × 0.8) / 12,000 = 1.33

After Market Fluctuations:

ETH price drops to $1500/ETH

• New Collateral Value: 15,000 USDC

• Health Factor = (15,000 × 0.8) / 12,000 = 1.0

Liquidation Execution:

• Liquidator can liquidate up to 50% of the debt: 6,000 USDC

• Assuming the current liquidation reward is 8%

• Liquidator pays 6,000 USDC and receives ETH worth 6,480 USDC

• Actual amount of ETH received = 6,480 / 1500 = 4.32 ETH

In the field of decentralized finance (DeFi), one of the core risk control measures of lending protocols is the liquidation mechanism. As a leading lending protocol, Aave ensures the stability and fund security of the platform through an automated and efficient liquidation system. This article will delve into Aave's liquidation mechanism, covering its triggering conditions, process design, roles of participants, and incentive measures.

What is Liquidation?

Liquidation refers to the process where the system automatically triggers a forced repayment when the value of a borrower's collateral is insufficient to cover the debt. Its core purpose is to prevent the risk of insolvency due to a sharp drop in collateral value or excessive accumulation of debt.

In Aave, liquidation is triggered based on two key parameters:

• Collateral Ratio: The ratio of the total value of collateral to the value of the debt.

• Liquidation Threshold: The minimum collateral ratio threshold preset by the system. When the collateral ratio falls below this threshold, the loan is considered "unhealthy," triggering liquidation.

For example, if the liquidation threshold for a certain collateral asset is 75%, liquidation will be automatically initiated when the value of the collateral falls below 75% of the debt value.

Note: Parameters such as liquidation thresholds and discount rates may vary with protocol version updates. Please refer to the official Aave documentation for the most accurate information.

When Does a Loan Become "Unhealthy"?

The following situations may lead to a deterioration in the health status of a loan:

• Decline in Collateral Asset Prices: For example, the price of the ETH pledged by the user plummets by 30%.

• Increase in Debt Size: For floating-rate loans, interest accumulation due to market fluctuations leads to an increase in the value of the debt.

• Insufficient Borrower's Repayment Capacity: The borrower fails to repay interest or principal in a timely manner.

Aave dynamically assesses the risk status of each loan by continuously monitoring the collateral ratio in real-time, combined with price data provided by oracles.

Core Design of Aave's Liquidation Mechanism

Health Factor

Aave introduces the Health Factor (HF) to quantify loan risk, with the calculation formula as follows:

HF = (Total value of collateral × Liquidation threshold) / Total value of debt

• HF > 1: The loan is safe, with sufficient collateral.

• HF ≤ 1: Insufficient collateral, triggering liquidation.

Note: Parameters such as liquidation thresholds and discount rates may vary with protocol version updates. Please refer to the official Aave documentation for the most accurate information.

Liquidation Process

Aave's liquidation process is fully automated, with the following specific steps:

• Risk Detection: The system continuously calculates the HF of all loans in real-time, with oracles constantly updating asset prices.

• Trigger Liquidation: When HF ≤ 1, the loan enters the liquidation queue.

• Liquidator Participation: Third-party liquidators can compete to repay the debt in exchange for purchasing the collateral at a discounted price.

• Debt Repayment: The liquidator repays part or all of the debt (up to a maximum of 50% of the debt) and receives the corresponding proportion of collateral (calculated at a discounted price).

• Remaining Processing: If the collateral is not fully liquidated, the borrower can still replenish the collateral or repay the loan to restore the HF.

Liquidation Penalties and Incentives

• Borrower Penalties: Borrowers who are liquidated must pay a liquidation penalty (usually 5 - 10% of the debt), which is credited to the protocol treasury or distributed to liquidity providers.

• Liquidator Incentives: Liquidators can purchase collateral at a discounted price (e.g., 95% of the market price), with the difference serving as a reward. For example, repaying $100 of debt can yield collateral worth $105 (a 5% discount).

Specific Liquidation Example

Initial State:

• Collateral: 10 ETH ($2000/ETH = $20,000)

• Loan: 12,000 USDC

• Liquidation Threshold: 80%

• Health Factor = (20,000 × 0.8) / 12,000 = 1.33

After Market Fluctuations:

ETH price drops to $1500/ETH

• New Collateral Value: 15,000 USDC

• Health Factor = (15,000 × 0.8) / 12,000 = 1.0

Liquidation Execution:

• Liquidator can liquidate up to 50% of the debt: 6,000 USDC

• Assuming the current liquidation reward is 8%

• Liquidator pays 6,000 USDC and receives ETH worth 6,480 USDC

• Actual amount of ETH received = 6,480 / 1500 = 4.32 ETH