Under-Collateralized Position

An under-collateralized position occurs when the value of the collateral backing a loan falls below the minimum requirement set by the protocol. This usually happens when the market price of the collateral drops, causing the loan-to-value ratio to exceed the liquidation threshold.

Such positions are at high risk of being liquidated by automated bots to protect the protocol's solvency. For the borrower, this represents a loss of their collateral, often accompanied by a penalty fee.

Managing an under-collateralized position is the core challenge of decentralized borrowing, requiring constant vigilance of market prices and collateral health. Protocols provide tools to top up collateral to avoid this state, but once the threshold is crossed, the liquidation process is typically irreversible.