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title: "How Liquidations Work"

Liquidation Icon

How Liquidations Work in Compound v3

Compound v3 uses an automated liquidation mechanism to protect the protocol from under-collateralized loans. When a borrower’s collateral value falls too low relative to their debt, liquidators can repay part of the loan and seize collateral at a bonus.

Liquidation Threshold​

  • Definition: The collateral value / debt ratio at which liquidation becomes possible.
  • Trigger: If Debt > Collateral Value × Collateral Factor, the position is liquidatable.

Liquidation Process​

  1. Detection: Price oracles update market prices; under-collateralized positions are flagged.
  2. Liquidator Action: A liquidator transaction repays a portion of the debt (up to the close factor).
  3. Collateral Seizure: Liquidator receives collateral at a discount (liquidation incentive).
  4. Partial vs. Full Liquidation: Typically partial; multiple repayments may occur until the position is healthy or collateral is exhausted.

Liquidation Incentive & Close Factor​

  • Liquidation Incentive: Bonus paid to liquidators for seizing collateral (e.g., 5-10% extra).
  • Close Factor: Maximum percentage of outstanding debt a liquidator can repay in a single transaction (protects borrowers).

Example Workflow​

  • Before Decline: Collateral = $10,000, Debt = $7,000 (70% LTV), CF = 75% → safe.
  • After Decline: Collateral drops to $9,000 → max borrowable = $9,000 × 75% = $6,750 → Debt ($7,000) > Limit.
  • Liquidation:
    • Liquidator repays $2,000 debt.
    • Liquidator receives $2,100 collateral (5% incentive).
    • Borrower’s new position: Collateral = $6,900, Debt = $5,000, now under threshold.

Next Steps​

Proceed to Module 2.2: Impact of Market Volatility to understand how price swings affect your position and strategies to manage that risk.

Let me know once this page renders correctly, and we’ll continue with Module 2.2!