What is Liquidation?

Liquidation happens when a borrower doesn't have enough collateral to cover their loan because the collateral's value has gone down or the loan's value has gone up. When this happens, and the borrower's health factor drops below 1, some of the borrower's debt is considered paid off. This amount, plus a fee for liquidating, is taken from whatever collateral the borrower has left.

What Happens with a Liquidation Penalty?

The extra charge you get hit with during liquidation, or the extra money someone gets for helping with the liquidation, depends on what you used as collateral.

An Example to Make It Clear

Let's use Alex as an example. Alex puts down 10 Ethereum (ETH) and borrows an amount in USD Coin (USDC) worth 5 ETH. If Alex's health factor goes under 1, his loan could be liquidated. A liquidator might pay off up to half of Alex's borrowed amount, which is 2.5 ETH in USDC. For doing this, the liquidator gets to take some of Alex's ETH, plus a little extra (5% more), so they get 2.625 ETH for the 2.5 ETH worth of USDC they covered.

How to Avoid Liquidation

If you don't want to be liquidated, you can improve your health factor by adding more collateral or paying back some of your loan. Paying back the loan usually helps more than just adding more collateral. It's also good to keep an eye on your health factor and try to keep it above 2 to stay safe.

Remember, the value of stablecoins like USDC can change because of the market, which can affect your health factor. For instance, 1 USDC might not always be equal to 1 USD; it could be a bit less.

Can You Join in on Liquidations?

Yes, anyone can join in on liquidations, but be ready for some tough competition. Many people who do liquidations use special tools and bots to be the first to liquidate and get the extra money from doing so.

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