Collateral liquidation is the execution of a sale, transfer, or seizure of pledged collateral after a collateralized stablecoin position breaches the conditions defined by the protocol.
When collateral values fall below the required threshold, the protocol can make the collateral available to liquidators, auctions, or automated markets. Proceeds are used to reduce or extinguish the associated stablecoin debt, and penalties can apply to the position owner. Execution quality depends on the reliability of price feeds, market depth, transaction capacity, and incentives for liquidators.
Collateral liquidation is the event in which collateral is disposed of. The liquidation mechanism is the rule set that determines when and how that event occurs.
Fast and orderly liquidations can protect the protocol from bad debt, while failed or delayed liquidations can leave outstanding stablecoins insufficiently collateralized.
A sharp fall in collateral value can trigger the protocol to auction the collateral and use the proceeds to repay the stablecoin debt.