Forced Liquidation Loops

Forced liquidation loops are sequences of events where the automated liquidation of collateral triggers further price declines, leading to more liquidations. These loops are particularly dangerous in DeFi, where smart contracts are programmed to sell collateral immediately when it falls below a specific threshold.

If the selling pressure from these liquidations is high enough to lower the price further, it can trigger liquidations for other users, creating a feedback loop. This mechanism can cause an asset's price to plummet in a very short period, often referred to as a cascade.

Preventing these loops requires careful design of liquidation incentives and market depth.