Liquidation Mechanisms and Price Impacts in DeFi

This paper examines the price impacts of liquidations in decentralized finance (DeFi) lending and how they vary with fixed-spread and auction-based liquidation mechanisms. Using a theoretical framework, we show that the impact of these mechanisms depends on the liquidator participation cost, which determines the level of competition. Auctions mitigate the price impact of liquidations when the participation cost is low, but amplify them when it is high. Empirical analysis of Ethereum blockchain data shows that auction-based liquidations lead to smaller price drops by increasing competition, which raises collateral prices and reduces liquidation volumes. These findings underscore the importance of liquidation design in promoting market stability and mitigating fire-sale risks in DeFi lending.

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Publication Details

Journal
Bank of Canada Research
Published
2025-03-24
DOI
https://doi.org/10.34989/swp-2025-12
Citations
1
Primary Topic
Forest Ecology and Biodiversity Studies
Type
article
Field-Weighted Citation Impact
1.67
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article

Liquidation Mechanisms and Price Impacts in DeFi

1 citations
Bank of Canada Research
Forest Ecology and Biodiversity Studies
1.67
article

Liquidation Mechanisms and Price Impacts in DeFi

article en
1 citations

Abstract

This paper examines the price impacts of liquidations in decentralized finance (DeFi) lending and how they vary with fixed-spread and auction-based liquidation mechanisms. Using a theoretical framework, we show that the impact of these mechanisms depends on the liquidator participation cost, which determines the level of competition. Auctions mitigate the price impact of liquidations when the participation cost is low, but amplify them when it is high. Empirical analysis of Ethereum blockchain data shows that auction-based liquidations lead to smaller price drops by increasing competition, which raises collateral prices and reduces liquidation volumes. These findings underscore the importance of liquidation design in promoting market stability and mitigating fire-sale risks in DeFi lending.

Bank of Canada Research
Bank of Canada (CA)
Openalex Percentile: Top 12%
Forest Ecology and Biodiversity Studies
1.67
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