Automated Liquidation Cascades

Automated liquidation cascades occur when a series of liquidations in a DeFi protocol triggers further price drops, leading to more liquidations in a recursive cycle. When a large position is liquidated, the protocol sells the underlying collateral on the open market, which puts downward pressure on the asset price.

If this selling pressure causes other positions to become under-collateralized, the liquidation engine will trigger more sales, creating a feedback loop. These cascades can lead to massive price volatility and potential insolvency for the protocol if the liquidation engine cannot find enough buyers for the collateral.

In highly leveraged environments, these cascades can happen in seconds, leaving no time for human intervention. This is a primary risk factor for systems that allow high leverage on volatile assets.

Protecting against this requires strict collateral requirements and deep liquidity in the underlying markets.