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What Are Liquidations?

The Risk of Liquidation

When you open a leveraged position, borrowing up to 6x the funds you add, the protocol needs to make sure you'll be able to pay back that loan. So the amount you add from your funds acts as collateral, which grows as you accumulate yields (minus borrowing interest). That collateral has to remain above the amount you owe (plus a margin of safety to account for potentially quick price movements or high gas) or the protocol may close your position to pay back lenders, which is called Liquidation. You want to avoid liquidation because at that time, depending on the collateral asset supplied your remaining position value would be paid to the liquidator bot as a reward for closing your position and ensuring lenders were paid back. Now, let's be clear. Liquidation is a risk, but only at certain times. When you first open a position, you typically do not have to worry about liquidation. If your strategy is profitable, you also shouldn't need to worry about it. So when would you have to worry about it? Well, since you've deposited crypto tokens, the value of your collateral is volatile and able to change as token prices move. What's more is that when you borrow funds, you are holding them and taking on the potential gains (and losses) of those assets while your position remains open. So that's the general overview of liquidation. However, as leveraged strategists, we're mostly concerned about price.
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