How Does Liquidation Occur in a CDP and What Is Its Purpose?
Liquidation occurs when the collateralization ratio of a CDP falls below the minimum threshold set by the smart contract, typically due to a drop in the collateral's market price. The smart contract automatically allows liquidators to buy the under-collateralized collateral at a discount to repay the outstanding debt.
The purpose is to maintain the solvency of the system and protect the peg of the synthetic asset. By forcing the repayment of debt, the system ensures that the total value of collateral always exceeds the total debt.
Glossar
Soft Liquidation Mechanism
Trigger ⎊ Soft liquidation mechanisms in cryptocurrency derivatives represent a pre-defined threshold breach, typically involving an asset’s price relative to a maintained margin level, initiating a controlled reduction of positions to mitigate systemic risk for exchanges and individual traders.
Cdp
Framework ⎊ Collateralized Debt Positions (CDPs) represent a core mechanism within decentralized finance (DeFi), specifically serving as the foundation for over-collateralized lending protocols.