DeFi Investors Brace for Liquidations as MakerDAO and Aave Call in Collateral

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Now comes the liquidation phase.

As crypto investors reckon with a 45% plunge in the value of the crypto market since November’s all-time high, the focus is now turning to the impact on leverage many investors use to amplify their earnings. Key platforms are liquidating the collateral users put up to secure borrowings, usually made in a stablecoin like DAI. 

Liquidations spiked to 1,692 on Aave, DeFi’s largest protocol, on Jan. 23. That’s the highest since the crash in late May 2021, according to data from The Defiant Terminal. 

Liquidations on Compound, Aave, and MakerDAO in the last year. Source: The Defiant Terminal

MakerDAO, another of DeFi’s largest protocols, had its own local high of 95 liquidations which came on Jan. 22. Like Aave, that was the highest mark since late May for the protocol. 

While the number of Aave liquidations outpaced Maker’s, the reverse was the case for USD-denominated value of the liquidations — Maker hit $118.8M in liquidations on Jan. 21, while Aave maxed out in terms of daily highs at $61.13M on Jan. 22, according to The Defiant Terminal. 

Liquidation Value in USD on Compound, Aave, and MakerDAO in the last year. Source: The Defiant Terminal

The Maker liquidations on Jan. 21 were discussed on Twitter by the protocol’s founder Rune Christensen who said there was over $600M in ETH in danger of liquidation at the time. While all $600M of the ETH wasn’t liquidated, the run on Jan. 21 represented the highest value of liquidation on Maker in the past year. 

The liquidation story in this selloff is important because it marks a big test for the functionality of DeFi in a high-stress period. While users have been rocked by liquidations in the past week, DeFi has continued to operate as intended, which is a bullish sign for its utility in the long term. 

Lever Up

Users make themselves susceptible to liquidation when they borrow against their collateral on DeFi protocols like Aave and Maker. In essence, these lending protocols allow the users to borrow assets, like Maker’s USD-pegged stablecoin DAI, if users are willing to lock up an asset like ETH. 

Users can only borrow up to a certain amount relative to their collateral. For example, Maker’s most popular vault allows users a max collateralization ratio of 145% which means that users up to $68,966 of DAI against $100,000 of ETH before getting liquidated.

Users often borrow in order to “lever up” on their crypto positions. To lever up on ETH, a user would deposit ETH into Maker, borrow DAI against that ETH, and then trade that DAI into more ETH, essentially increasing their stack of the cryptocurrency in exchange for liquidation risk as well as Maker’s interest rates. 

An Exception

In the meantime, the plunge in token values themselves may continue to put pressure on the space and exacerbate liquidations. Ethereum has dropped 25% in the last week to $2,401, a price level web3 enthusiasts haven’t seen since July when the cryptocurrency was coming out of a severe sell-off in May.

Other major Layer 1s (L1) are down too — in fact, all major L1 smart contract platforms, have lost a fifth of their value in the last seven days, according to CoinGecko.

The exception is Terra’s LUNA, which is down 16.9% in that time span. Cosmos’ ATOM, arguably a Layer 1 though not categorized as a smart contract platform by CoinGecko, is also down 8.2% on the week.

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