Liquidation in crypto means converting your assets to fiat currencies. Learn all about liquidations, flash loans, and lending protocols in this article.
The term "liquidation" refers to the process of converting assets into cash. It can also refer to the sale of poor-performing goods at a price lower than the cost to the business or lower than the price desired by the business.
In a broader sense, liquidation is the process of converting a company's assets into cash and using those funds to repay as much of the company's debts as possible.
Now that we've covered the broad meaning of liquidation let's look at liquidation meaning in crypto.
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If you are wondering about "liquidation meaning in crypto," this answers your thoughts. The term "liquidation" in crypto is commonly used to describe the forced closing of a trader's position due to a partial or total of the trader's initial margin, and this occurs when they are unable to meet the margin requirements for their leveraged position, that means the trader does not have enough funds to keep the trade open.
When liquidation occurs, the exchange will automatically close the trader out of the position, resulting in a loss of funds for the trader. The magnitude of this loss will be determined by the initial margin in place and the price drop. It can result in a total investment loss in some cases.
Now let’s bring the concept home to defi. Liquidation occurs in traditional finance when a firm or corporation must sell part of its assets at a loss to pay off a debt. DeFi liquidation is similar in that users borrow from a protocol and offer crypto assets as collateral. As a result, DeFi liquidation is the process of a smart contract selling crypto assets to pay off a debt.
Just like in traditional finance, most DeFi lending platforms require overcollaterization. In essence, the borrower must first deposit another cryptocurrency asset worth a specific percentage more than the amount borrowed. The Aave lending platform, for example, allows any user to borrow up to 75% of the current value of any assets locked with the platform's protocol. This means that when the value of the assets rises, so does the "credit limit" for the user. On the other hand, if the value of the locked assets diminishes, a liquidation event may occur.This is where flash loans come in; flash loans provide DeFi users with an uncollateralized loan option.
Next to the search for "liquidation meaning in crypto" is "What are flash loans?"
Flash loans are popular loans within the cryptosystem, particularly among Ethereum-based Defi protocols. They are a type of uncollateralized lending system; they involve a lender loaning money to a borrower with the expectation that they will get paid back. Flash loans encompass the entire transaction, from borrowing to paying back, in a single, instant transaction. The flash loan smart contract does all the trick. When deployed, it automatically gives you access to the borrowed amount and returns the funds as soon as the project’s returns arrive.
Flash loans have the following distinctive properties:-
Smart contracts: In flash loans, smart contracts, which are blockchain-based contracts that prohibit fund exchange unless certain criteria are met, are used. The borrower must return a flash loan before the transaction ends; otherwise, the smart contract reverses the transaction, making the loan appear to have never occurred.
Instant lending: Borrowers who are approved for a traditional loan must typically repay the loan over some time. On the other hand, a flash loan is completed in a matter of seconds. The smart contract for the loan must be met by both parties simultaneously as the loan payout. The borrower must use other smart contracts to conduct immediate transactions with the loaned funds before the deal expires, which normally takes a few seconds.
Unsecured loan: Lenders frequently demand borrowers put up collateral to ensure that if the borrower cannot repay the loan, the lender will still be able to recover their funds. An unsecured loan, meanwhile, does not require any collateral. Despite the lack of collateral, lenders are assured of their money because borrowers pay back their loans immediately.
Flash loans can be obtained from flash loan lending protocols like Equalizer. Before you choose a platform to obtain your flash loan from, it is vital to consider the fees, gas efficiency, user-friendliness, and safety.
When you borrow money from a centralized exchange and reach the liquidation point, you will receive a margin call, or a centralized party will liquidate your collateral. In contrast, on DeFi, the platforms rely on third parties like you to determine when these liquidations need to occur. Users are rewarded for identifying and then liquidating other users.
Liquidators are users who participate in liquidation. Anyone can participate in liquidations, although there is a lot of competition. Liquidators can participate in liquidations in a variety of ways. Most liquidators like to develop their solutions and bots to be the first to liquidate loans to receive the liquidation bonus.
Here are some DeFi platforms that allow you to compete for liquidations:
Aave: Aave is a non-custodial decentralized money market platform that allows users to engage as lenders or borrowers. Lenders receive a passive income by providing liquidity to the market, while borrowers can borrow cryptocurrencies in exchange for paying a variable interest rate.
dYdX: dYdX is a decentralized exchange based on the Ethereum network that provides users with important financial products such as perpetual, margin, and spot trading, as well as lending and borrowing.
As stated earlier in the article, liquidation occurs when the value of the collateral asset falls below a certain predetermined level. This is usually to avoid a situation whereby the collateral value is insufficient to cover the loan borrowed. In a situation where the collateral's value hits the liquidation point, the smart contract sells the crypto asset to pay off the debt. The user is charged the fee and loses the asset.
To liquidate the crypto assets, a third-party liquidator gains access to the deposit to trigger the smart contract. These platforms have incentive mechanisms that allow users to liquidate and receive a reward occasionally. The liquidator's job is to trade the locked assets to the one where the debt is taken. The liquidator then repays the debt on the borrower's behalf, earning a liquidation bonus. Because there are so many token pair combinations, the liquidators must have a large amount of liquidity in various fluctuating assets to make the swaps, resulting in a high level of inventory risk.
Flash loans serve as a solution to the inventory risk. Liquidators do not need to keep these volatile stocks for fast loans. They could take out a flash loan from one of the major lending platforms, payback on behalf of the borrower, release the deposit, swap it for the token used to take the flash loan, pay back the loan from the lending platform, and receive the bonus. The flash loan smart contract takes care of all the steps for you.
For example, Let's say a trader uses ETH as collateral while trading on the exchange. If he trades long on a futures trade and then the price of ETH begins to dip. As it approaches the liquidation, a third-party liquidator could seek for flash loans to initiate the liquidation process and receive a bonus by doing the following:
Flash loans are made possible by lending protocols or platforms. These platforms provide cryptocurrency loans in a trustless manner, allowing holders to stake their coins in DeFi lending platforms for lending purposes. A borrower can take out a loan on the lending platform, allowing the lender to earn interest once the loan is repaid. The lending process is carried out in one transaction without intermediaries from start to finish.
The lending protocols are funded by a liquidity pool based on a smart contract. And how does this work? A coin holder sends the token they want to lend into the liquidity pool. Once the coins are placed in the pool, they are available to other users who wish to borrow them. Following that, the smart contract generates tokens that are automatically distributed to the lender. In addition to the underlying assets that were sent to the smart contract, the tokens can be redeemed at a later time.
Popular DeFi lending protocols include Equalizer, Aave, and dYdX
Aave: The collateral asset determines the liquidation penalty or bonus for liquidators on Aave. The liquidation bonus is typically 5-10% of the asset value.
dYdX: On dYdX, the liquidator receives the liquidated account's collateral plus a 5% liquidation fee as a reward. A dYdX liquidation, from the perspective of the liquidator, entails automatically repaying another account's borrowed asset.
To build a liquidation bot, you need to know how to write a script according to the protocol you use in competing for liquidation.
It would be best if you did the following to create a liquidator bot:
Note: You must run an Ethereum node, such as Infura or Geth, to monitor the Ethereum blockchain.
Equalizer is the world's first flash loan marketplace, created to meet the growing demand for DeFi lending and borrowing. It stands out by offering the lowest fees and transaction costs and a nearly infinite number of token vaults, high liquidity through yield farming, scalable, multi-chain architecture, and integration-friendly features. Equalizer uses TWO times less gas fee than its competitors for a flash loan call regarding gas efficiency. It also has an easy-to-use interface and system and user support.
Below are some of the reasons that make Equalizer stand out amongst other DeFi lending protocols.
Here is a guide on how to apply for a flash loan from Equalizer Vaults:
To obtain a flash loan, firstly, you must create and deploy a Flash Borrower smart contract, which borrows a flash loan, executes a business transaction, and then returns the loan with the borrowing fee included. Only funds are borrowed and returned by the smart contract. The user must supply the business logic.
Open the Flash Loan Provider: The Equalizer Flash Loan Provider is a smart contract that allows you to borrow flash loans. The Flash Loan Provider can be inspected on Etherscan.
Connect your wallet: Click 'Connect to Web3' to connect your wallet. A wallet window will appear, prompting you to connect to your wallet. Make sure to select one of the supported wallets, such as Metamask.
Borrow a flash loan: Now, you can borrow a flash loan. Click on the flashLoan function to enter function parameters such as the recipient's address, token address, amount, and data. Then, click 'Write' and sign the transaction. When the transaction has been successfully processed, you can inspect it.
That is it. It's as simple as that to apply for a flash loan on Equalizer.
The liquidation price for a given contract is an estimate of which mark price level will cause the contract to liquidate. This is only an estimate and should not be considered fixed, as various factors can influence it. You are responsible for monitoring your account balance and exposure to ensure you take the risk you are comfortable with.
Yes. However, things may change in the future as the crypto space becomes more regulated.
Potentially, if you thoroughly examine both the protocol, you plan to borrow from and the protocol you intend to send the borrowed capital. Some people have used these loans to make a lot of money rapidly. However, as recent attacks on flash loans have demonstrated, the technology is not without risks.
DeFi platforms rely on third parties to determine when liquidations need to occur.
Liquidators are users who participate in liquidation. Anyone can participate in liquidations, although there is a lot of competition. Liquidators can participate in liquidations in a variety of ways. Most liquidators develop their solutions and bots to be the first to liquidate loans to receive the liquidation bonus.
