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What Is a Liquidation Mechanism in DeFi Derivatives and Why Is It Necessary?

It is the automated closing of an undercollateralized position to prevent bad debt for the protocol, triggered by an incentivized entity.
Greeks.Live16.11.25

What Is a Liquidation Mechanism in DeFi Derivatives and Why Is It Necessary?

A liquidation mechanism is the automated process by which a smart contract forcibly closes a leveraged trading position when the collateral value falls below a minimum threshold, known as the maintenance margin. It is necessary to prevent the trading platform or the protocol's insurance fund from incurring bad debt.

The mechanism is triggered by an external entity (a 'keeper' or liquidator) who is incentivized by a small fee to execute the transaction that closes the position and sells the collateral.

How Is the Upgrade Function Typically Triggered in a UUPS Contract?
What Is the Purpose of ‘Maintenance Margin’ and When Is a Margin Call Triggered?
What Is the Risk of Liquidation in a Highly Leveraged Naked Call Position?
What Is the Role of the ‘Liquidation Penalty’ in Maintaining the Health of a Collateralized Debt Position (CDP)?

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