Liquidations Volume

Overview

The Liquidation Volume in a DeFi protocol refers to the amount of funds that are seized and sold in the event that a borrower is unable to repay their loan. Liquidations occur when a borrower's collateral falls below a certain value, known as the liquidation threshold.

Here’s an explain it like I’m 5 example of how liquidations take place, where a borrower, Alice, borrows $100 USDC against $140 worth of ETH:

• The value of Alice’s ETH drops to its liquidation threshold, which can be calculated based on its collateral factor.

• Since the USDC borrowed by Alice is someone else’s deposit – let’s say Bob’s USDC – into Compound v2, the protocol needs to make sure Bob gets his $100 back

• In order to repay the loan, a liquidator, Carl, claims part of Alice’s ETH and slightly less USDC into the protocol, making the difference (known as liquidation bonus)

• This way liquidators like Carl make sure depositors like Bob don’t lose their deposits to borrowers such as Alice taking risky loans

If the value of Alice’s ETH drops such that her position is undercollateralized (i.e. she has less ETH supplied than USDC borrowed) before Carl can liquidate it, then depositors like Bob end up losing part of their funds and the protocol ends with “bad debt”.

How can I use it?

The Liquidation Volume in a DeFi protocol provides insight into the level of risk in the system, as higher liquidation volumes can indicate that more borrowers are defaulting on their loans and that the protocol is exposed to greater risk.

In addition, it also provides a sense of the value being obtained by liquidators in order to protect the protocol from bad debt exposure.