What is a liquidation in DeFi: the keeper, the bonus, the mechanics
What is a liquidation in DeFi: the keeper, the bonus, the mechanics
A liquidation in DeFi is the forced closure of a borrower's position once their collateral value falls too close to their loan value. Nobody calls the borrower first. The protocol's code detects the breach and lets anyone execute the liquidation, automatically, the moment the threshold is crossed.
How it works
Every crypto-collateralized loan carries a liquidation threshold, the loan-to-value ratio at which the position becomes eligible for liquidation. As collateral price falls (or as accrued interest pushes the loan balance up), a borrower's LTV climbs toward that threshold. Cross it, and the loan becomes fair game: not for the protocol itself, but for keepers, independent actors (often automated bots) who monitor every open position on-chain, watching for exactly this moment.
The moment a position crosses its threshold, a keeper submits a transaction that repays part or all of the outstanding loan on the borrower's behalf and, in exchange, receives an equivalent value of the borrower's collateral plus a bonus, typically 5-15% of the amount liquidated, paid out of the borrower's remaining collateral. That bonus is the entire incentive structure: it's what makes hundreds of bots race to be the first to submit a liquidation transaction the instant a position becomes eligible, which is also why liquidations tend to execute within seconds of a threshold breach rather than sitting exposed.
The borrower, from their side, experiences this as an instant and often startling loss: a position that looked fine the day before can get partially or fully liquidated in a single sharp price move, with the liquidation bonus coming directly out of collateral the borrower would otherwise have kept.
Why it matters
The keeper-and-bonus mechanism is what lets DeFi lending function without a human collections department. Because anyone, anywhere, can execute a liquidation the second it's eligible, protocols don't need to trust a specific liquidator to show up; they need only make the trade profitable enough that competition guarantees someone will.
The mechanism has a real weak point: it depends on liquid, deep markets to actually sell seized collateral without moving the price against the liquidation itself. In periods of extreme volatility or thin liquidity, liquidations can fail to fully execute, or execute at prices bad enough that even the liquidation bonus doesn't fully cover the protocol's bad debt, which is exactly what happened across several lending markets during the sharpest crypto price crashes.
Where this shows up in Rekord
Rekord's institutional lending markets set collateral thresholds conservatively enough to keep a real buffer between a borrower's operating LTV and the point of liquidation, precisely because instant, keeper-driven liquidation is the backstop, not the first line of defense. For how that buffer gets sized, see LTV vs LLTV: origination threshold vs liquidation trigger.