DeFi Liquidations: Why You Lose MORE Than the Price Drop
You deposit $10,000 worth of $ETH H and borrow $8,000 USDT.
Market crashes. Your collateral hits the liquidation threshold.
You might think:
👉 “The protocol will just sell $8,000 of my $ETH to repay the loan. I’ll keep the rest.”
Wrong.
Welcome to the brutal reality of Liquidation Penalties.
⚙️ How Liquidation Actually Works
DeFi protocols don’t manually sell your collateral.
They rely on external Liquidators—high-speed bots that monitor positions 24/7.
To incentivize these bots, the protocol offers a reward:
Liquidators get to buy your collateral at a 5%–15% DISCOUNT.
Who pays for that discount?
👉 YOU DO.
🧮 The Real Math Behind the Pain
Assume you owe $10,000, and your position gets liquidated.
Liquidation penalty = 10%.
To repay your debt, the protocol doesn’t sell $10,000 of collateral.
It sells $11,000 worth of your ETH.
Why?
Because the bot gets a 10% discount and immediately pockets the $1,000 difference.
You lose $11,000 of collateral, but only $10,000 goes to cover your loan.
The extra $1,000 becomes the Liquidator’s profit — taken straight from your bag.
That's how you lose more than the price drop.
🛡️ Your Lifeline: The Health Factor (HF)
The HF determines how close you are to liquidation:
HF = (Collateral × Liquidation Threshold) / Debt
HF > 1.0 → Safe
HF < 1.0 → Automatic liquidation
No warnings.
No margin calls.
Bots will liquidate you at 0.9999 without hesitation.
⚠️ Why DeFi Liquidations Hurt More Than CEX Margin Trades
Higher penalties
Instant liquidation
Zero human review
Bots react in milliseconds
That’s why experienced DeFi users follow one rule:
Never Max Borrow — Keep HF above 1.5 or even 2.0 to sleep peacefully.
