What Are the Consequences of a Collateralized Position Falling below a ‘Liquidation Threshold’?
When the value of the collateral falls below a predefined liquidation threshold, the smart contract automatically triggers a liquidation event. The contract then sells the collateral, often at a discount, to repay the outstanding debt or settle the derivative position.
This automated process prevents the protocol from taking a loss but results in a penalty fee for the position holder.
Glossar
Collateralized Position
Position ⎊ A collateralized position, within cryptocurrency derivatives and options trading, represents an obligation secured by pledged assets, typically digital currencies or tokenized representations of real-world assets.
Penalty Fee
Deterrent ⎊ The penalty fee serves as a financial deterrent, discouraging position holders from allowing their collateralization ratio to drop below the safe liquidation threshold, thereby preventing an automatic sale.
Smart Contract
Code ⎊ The contract is fundamentally self-executing code deployed on a distributed ledger, embodying the terms of the agreement in an immutable format.