A liquidation process occurs when a borrower’s health factor goes below 1 due to their collateral value not properly covering their loan/debt value. This might happen when the collateral decreases in value or the borrowed debt increases in value against each other. This collateral vs loan value ratio is shown in the health factor*.
* The health factor is the numeric representation of the safety of your deposited assets against the borrowed assets and its underlying value. The higher the value is, the safer the state of your funds are against a liquidation scenario. The health factor depends on the liquidation threshold of your collateral against the value of your borrowed funds
In a liquidation, up to 50% of a borrower’s debt is repaid and that value + liquidation fee is taken from the collateral available, so after a liquidation that amount liquidated from your debt is repaid.
In AAVE protocol, only those deeply understanding the technical aspect can create bots to join the liquidation ecosystem and get the reward from this unique function. With the aim of turning blockchain into web views for any users (not only for super users but anyone), Xpool builds a nice view on our protocol known as Liquidation Market- where all the under collateral loans are listed.
Anyone in the Xpool protocol can join our liquidation market and help to liquify part of the loan (maximum 50% amount of borrowing). The first ones liquidating loans will get the liquidation bonus about 5–15% collateral value (depending on the asset used as collateral).
For instance, you deposit 5 BNB and borrow 2 BNB worth of CAKE. When your health factor goes down below 1, your loan will be eligible for listing on the liquidation markets. A liquidator can repay up to 50% of a single borrowed amount = 1BNB worth of CAKE. In return, the liquidator can claim a single collateral which is BNB (5% bonus). The liquidator claims 1 + 0.05 BNB for repaying 1 BNB worth of CAKE.
To avoid this liquidation process, you need to raise your health factor by depositing more collateral assets or repaying part of your loan. By default, repayments increase your health factor more than deposits. Also, it’s important to monitor your health factor and keep it high to avoid liquidation. Keeping your health factor over 2, for example, gives you more of a margin to avoid a liquidation.