Borrowing on DeFi
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 8 min
In short
Borrowing in DeFi means posting collateral and drawing a fraction of its value. You move toward liquidation if the borrowed asset rises in price *or* if the collateral falls. Liquidation takes part or much of the collateral, and it is executed automatically — with no grace period and no notification.
Key points
- Your borrowing limit is a fraction of collateral value, and borrowing to that limit is extremely dangerous
- A rise in the borrowed asset moves you toward liquidation just as a fall in collateral does
- Liquidation executes automatically, with no warning, no grace period, and a penalty deducted
- Interest accrues while you are borrowed, so an untouched position drifts toward the threshold by itself
Definition
Posting crypto as collateral with a lending protocol and drawing another asset up to a set fraction of that collateral's value. If the collateral's value falls below the threshold, the position is forcibly liquidated.
Start with why the collateral must exceed the loan. DeFi has no credit checks and no way to pursue a debtor, so collateral is the only protection the lenders have. You may therefore draw less than the collateral is worth, and the system builds in liquidation: when the collateral gets close to insufficient, a third party sells it to repay the debt. That is not a punishment; it is the component that makes the whole thing work.
In practice you verify the domain, connect, deposit the collateral asset and enable it as collateral. Then you choose what to borrow and how much, and sign. Interfaces generally show your borrowing limit and a health indicator at this point. Treat the limit as the line past which you are liquidated immediately — not as a target to reach.
Here is the point that matters most. Two things push you toward liquidation: your collateral falling, and the asset you borrowed rising. If you borrowed a stablecoin, the first dominates. But borrow a volatile asset and you approach the threshold purely because it appreciated, with your collateral untouched. Miss that asymmetry and you end up liquidated while wondering why, since the collateral never dropped.
Time alone also grows the debt. Interest accrues on the outstanding balance at a rate that floats with demand. A position you never touch still deteriorates, because the debt side keeps expanding relative to the collateral. Borrowing and then leaving it alone for a long period is, by construction, a slow drift toward the danger zone even in a flat market.
Finally, be concrete about what liquidation costs. Typically the collateral covers the repayment plus a penalty paid to whoever executed the liquidation. Once taken, it does not come back when prices recover. In sharp sell-offs, liquidations can cascade, pushing prices lower and leaving you processed on worse terms than you modelled. Borrowing is a trade in which losing the collateral is one of the outcomes.
Watch out for
- · You are liquidated not only when collateral falls but also when the borrowed asset rises. The risk runs in both directions
- · Liquidation executes automatically with no notice and no grace period. A penalty comes out of your collateral and is not restored when prices recover
- · Where a price feed briefly reports a wrong value, positions that were healthy at true market prices have been liquidated anyway
Frequently asked questions
Why not borrow up to the limit?
The limit is the boundary beyond which you are liquidated. Borrowing right up to it means the smallest price move triggers it. There is no correct amount of headroom, but the more volatile your collateral and the longer the periods when you cannot react, the more of it you need.
If I get liquidated, do I still owe the borrowed asset?
Liquidation sells collateral to repay the debt, so you keep the borrowed asset. But the collateral used for repayment, plus the penalty on top, is gone. Net of everything, you have disposed of your collateral on unfavourable terms.