Liquidation occurs when a borrower's collateral value falls below a certain threshold, making the loan risky. To protect the system, third-party participants, known as liquidators, can repay the borrower's debt and claim either part or all of the collateral, usually at a discount. As an incentive, liquidators typically receive a 2.5% fee from the collateral for their role in stabilizing the lending pool.

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In simple terms, the liquidator repays the loan and receives part of the collateral to compensate deb + fee.

Liquidation threshold

The Liquidation Threshold (LT) is a crucial metric that specifies the loan-to-collateral ratio at which a loan becomes subject to liquidation. LT is a key value when determining the health factor:

HealthFactor=CollateralValue/DebtValue/LiquidationThresholdHealthFactor = CollateralValue/DebtValue/LiquidationThreshold

Liquidation Threshold is defined at the time of pool creation as a pool parameter. In the event of liquidation, the liquidator is expected to swap the acquired collateral asset for the loan asset, which could move the market and result in cascading liquidations. Therefore, a higher LT should be applied to low-liquidity collateral assets, while a lower LT is suitable for more liquid assets.

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