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Liquidation protects lenders by closing undercollateralized positions and keeping markets solvent. If you’re integrating borrowing, you need to explain when and how liquidation works. When your position becomes too risky, a liquidator can repay your debt and seize your collateral at a discount.

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When liquidation occurs

A position can be liquidated when its health factor is 1 or below—that is, when LTV meets or exceeds the market’s LLTV (Liquidation Loan-to-Value). Debt value / Collateral value ≥ LLTV → position is liquidatable. Common causes:
  • Collateral price falls
  • Debt grows from accrued interest

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Liquidation process

Bend liquidations are not auctions. The first liquidator to act repays debt and receives collateral at a discount in one transaction.
  1. Unhealthy position: A liquidator (often a bot) finds a position with health factor ≤ 1.
  2. Repay debt: The liquidator calls liquidate on the Bend contract and repays some or all of the debt in the loan asset.
  3. Seize collateral: The liquidator receives collateral worth the repaid amount times the Liquidation Incentive Factor (LIF).
  4. Position updated: The borrower’s debt and collateral are reduced accordingly.

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Liquidation Incentive Factor (LIF)

The LIF is the bonus a liquidator earns. It is derived from the market’s LLTV; higher LLTV means a smaller bonus to limit cascades. For LLTV 86%, LIF ≈ 1.05 (about a 5% bonus on seized collateral). The full incentive goes to the liquidator; Bend does not take a fee. Formula: LIF=min⁡(maxLIF, 1(1−β)×(1−LLTV))\mathrm{LIF} = \min \left( \mathrm{maxLIF},\ \frac{1}{(1 - \beta) \times (1 - \mathrm{LLTV})} \right)
  • LLTV: Market liquidation threshold (e.g. 0.86)
  • β = 0.3 (constant)
  • maxLIF = 1.15 (15% cap)

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Example (LLTV 86%)

  • Before: Debt $87,000, collateral $100,000 → LTV 87% > 86% → liquidatable.
  • Liquidator repays $87,000 and receives $87,000 × 1.05 = $91,350 of collateral.
  • Borrower: Debt cleared; $4,350 loss (collateral drop).
  • Liquidator: $4,350 profit (minus gas).

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Bad debt

If collateral value falls below the debt (LTV > 100%), a liquidation may not cover the full loan. The shortfall is bad debt and is a loss to lenders in that market. Isolated markets and conservative LLTVs are designed to make this rare.