Crypto glossary
Liquidation threshold
The liquidation threshold is the collateral ratio at which a DeFi loan can be liquidated, usually set a few points above the maximum loan-to-value.
Every asset accepted as collateral on a lending protocol carries a liquidation threshold. If ETH has a threshold of 83%, a position becomes liquidatable once the debt exceeds 83% of the collateral's current value. The threshold sits above the maximum loan-to-value allowed when borrowing, leaving a buffer so that small price moves do not trigger liquidations immediately.
When the line is crossed, third parties can repay part of the debt and receive collateral at a discount, the liquidation bonus or penalty, often between 5% and 10%. That discount is the incentive that keeps protocols solvent, and the borrower bears it. Thresholds are lower for volatile or illiquid tokens and higher for stablecoins or correlated pairs such as staked ETH against ETH.
Thresholds are applied to oracle prices, not to what a user sees on an exchange, so a brief oracle spike can liquidate a position. Governance can also lower thresholds for risky assets, which may push existing loans close to liquidation without any market move.
Example
Alice deposits 10,000 dollars of ETH with an 80% threshold and borrows 7,000 USDC; if ETH falls 13%, her collateral is worth 8,700 dollars, the debt crosses the line and a liquidator takes part of her ETH at a discount.