Trail notes
- A liquidation is when a lending protocol lets someone repay part of your loan and take your collateral at a discount.
- It triggers when your health factor falls to 1 or below, from a price drop, growing interest or a rise in what you borrowed.
- You pay a liquidation penalty on top, and cascades and gas spikes can make it hard to act in time.
- As of 2026-10-30, CRA has published no DeFi-specific guidance on lending, borrowing or liquidations.
What liquidation risk is
When you borrow on a DeFi lending protocol, you lock up collateral worth more than the loan. The protocol keeps watching the value of that collateral. If it falls too far relative to what you owe, anyone can step in, repay part of your debt and take some of your collateral at a discount. That is a liquidation, and it happens automatically, at any hour, without a warning call first.
Liquidation risk is the chance that this happens to you, plus the cost when it does. It applies whenever you borrow against crypto, whether the loan is small or part of a leveraged strategy.
We rate liquidation risk 4 (high) on the Mitey risk scale, our editorial teaching scale inspired by avalanche danger ratings: 1 low, 2 moderate, 3 considerable, 4 high, 5 extreme. It is a general teaching guide, not advice. We put it at 4 because crypto prices can fall far and fast, liquidations are automatic, and the penalty means you lose more than the price move alone.
How it happens
Each lending market sets a liquidation threshold for every type of collateral: the share of the collateral’s value you can borrow against before you become eligible for liquidation. Many protocols sum your position up as a health factor.
In its common form, health factor = (collateral value × liquidation threshold) ÷ debt value. Above 1, your position is open for now. At or below 1, it can be liquidated. Protocols differ in the details, so read the documentation for the one you use.
- Price drop. Your collateral falls in value and your health factor falls with it.
- Debt growth. Interest adds to your debt over time. If you borrowed a volatile asset, a rise in its price raises your debt too.
- The penalty. Liquidators are paid with a discount on your collateral, often called a liquidation bonus. You lose that slice on top of the collateral used to repay your debt.
- Cascades. When many positions are liquidated at once, seized collateral is sold, which pushes prices down further and triggers more liquidations.
- Gas spikes. Network fees rise when everyone tries to act at the same time. A top-up that normally costs little can become expensive or slow to confirm just when you need it. See gas fees explained.
- Price feed timing. The protocol uses an oracle price, not the price on your chart. A sudden move, a stale feed or a manipulated feed can trigger liquidation. See oracle manipulation.
See the full infographic with notes.
A worked hypothetical example
All figures are invented. Real thresholds, bonuses and the share of debt a liquidator may repay at once vary by protocol. The useful habit is the arithmetic: in this example, a 37.5% fall in collateral was enough. Try your own numbers in the liquidation explorer or see the health factor infographic.
Warning signs
- Your health factor drifting toward 1, even slowly.
- High volatility in your collateral asset, or a broad market sell-off.
- Rising network fees and slow confirmations.
- The asset you borrowed rising in price, if it is not a stablecoin.
- Collateral that is thinly traded, or whose price comes from a single source.
- Borrow rates jumping, which grows your debt faster.
- No way to reach your wallet quickly, for example while travelling.
How to reduce it
- Borrow less than you can. A starting health factor well above the minimum gives you room for a large price move. Choose your own buffer before you borrow, not after.
- Know your liquidation price. Work out the collateral price at which your health factor reaches 1, and write it down.
- Keep a top-up plan. Hold spare collateral or repayment funds in the same wallet, on the same network, plus enough of the network’s gas token to pay elevated fees.
- Set alerts, but do not rely on them alone. Alerts can fail, or arrive while you are asleep.
- Avoid looping. Borrowing, redepositing and borrowing again multiplies exposure and shrinks the distance to liquidation.
- Repay early when in doubt. Reducing debt raises your health factor immediately, without depending on prices recovering.
Crypto prices can gap through any level in minutes. A wide buffer lowers the chance of liquidation; it does not remove it. Size any loan so that a liquidation would be painful but not ruinous.
The Canadian angle
Borrowing against crypto in Canada can happen in two very different places.
On the platform side, the CSA reminded crypto-backed lending platforms on 2025-10-22 that their activities may involve securities requiring registration, and urged investors to check that a platform is registered or has exemptive relief. You can check through the CSA’s National Registration Search.
On the DeFi side, a lending protocol you reach from your own wallet is code, not a registered firm. Crypto collateral has no CDIC coverage (CDIC’s “What’s covered” page, checked 2026-10-30), and there is no one to call if a liquidation fires overnight.
As of 2026-10-30, CRA has published no DeFi-specific guidance on lending or borrowing, including how a liquidation should be treated. CRA does list trading one crypto-asset for another as a disposition. Record each liquidation with its date, amounts and CAD values, and ask a tax professional how it applies to you.
Your checklist
Questions people ask
What triggers a DeFi liquidation?
A liquidation is triggered when your collateral value, adjusted by the protocol’s liquidation threshold, no longer covers your debt, which many protocols show as a health factor at or below 1. A price drop, growing interest or a rise in the value of what you borrowed can all get you there.
How much does a liquidation cost?
You lose the collateral used to repay your debt plus a liquidation bonus paid to the liquidator. Each protocol sets its own bonus; the example on this page uses 5% purely for illustration.
Why can’t I just top up when prices fall?
You can, if you act in time and can pay the fee. During sharp sell-offs network fees often rise and transactions can take longer to confirm, so a top-up plan works best when funds and gas are already in place.
Does CRA treat a liquidation as a sale?
CRA has not said. As of 2026-10-30 it has published no DeFi-specific guidance on lending, borrowing or liquidations, so record each event and get professional tax advice.
Sources and dates
- Decentralized finance (DeFi) — ethereum.orgreference
No date shown on page · checked 2026-10-31. Overview of DeFi building blocks on Ethereum. - Gas and fees — ethereum.orgreference
No date shown on page · checked 2026-10-31. How transaction fees (gas) work on Ethereum. - Oracles — ethereum.orgreference
No date shown on page · checked 2026-10-31. How off-chain data reaches smart contracts, and oracle risks. - CSA reminds crypto-backed lending platforms of potential regulatory requirements — Canadian Securities Administratorsin force
Page date 2025-10-22 · checked 2026-10-30. Crypto-backed lending may involve securities requiring registration; check registration or exemptive relief. - Are they registered? (National Registration Search) — Canadian Securities Administratorsreference
Page date 2026-01-13 · checked 2026-10-30. Check registration, disciplinary history and investor alerts. - What's covered — Canada Deposit Insurance Corporationin force
No date shown on page · checked 2026-10-30. Up to $100,000 per category per member institution; cryptocurrencies, including stablecoins, are not covered. - Information for crypto-asset users and tax professionals — Canada Revenue Agencyin force
Page date 2025-10-29 · checked 2026-10-30. CRA's current crypto-asset guidance set (replaced the older 'Guide for cryptocurrency users'). - Reporting income from crypto-asset transactions — Canada Revenue Agencyin force
Page date 2025-12-02 · checked 2026-10-30. Business income vs capital gains is case by case; lists business indicators; crypto-to-crypto trades are dispositions; half of a capital gain is taxable.
Education only. Nothing on this page is financial, investment, tax or legal advice, or a recommendation to buy, sell, stake, lend or borrow any crypto-asset. Crypto-assets can lose some or all of their value and are not covered by CDIC. Canadian rules change: check the dated sources above and talk to a qualified professional about your situation. Full disclaimer.