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.