Liquidation Engine Feedback

Liquidation engine feedback is the process by which the software responsible for liquidating undercollateralized positions inadvertently contributes to market volatility. These engines operate by selling collateral on the open market, often using automated bots.

If the market is thin, these large sell orders can cause significant price drops, which in turn make other positions undercollateralized. This feedback loop is a major contributor to the rapid price crashes seen in crypto derivative markets.

Developers attempt to mitigate this by implementing features like auction mechanisms or gradual liquidation processes. However, these solutions can sometimes be too slow during extreme market moves.

Balancing the speed of liquidation with the impact on market price is a constant challenge in protocol design.