The decentralized finance (DeFi) ecosystem has witnessed exponential growth, with total value locked (TVL) surpassing $4.3 billion—a 300% increase year-over-year. At the heart of this expansion are lending protocols like **Compound**, **MakerDAO**, and **Aave**, which collectively account for $1.3 billion in TVL (30% of the DeFi market).
How DeFi Lending Works
DeFi lending involves four key participants:
- Borrowers - Provide crypto collateral to borrow assets
- Depositors - Supply liquidity to earn interest
- Liquidators - Act as risk mitigators
- Platforms - Facilitate transactions via smart contracts
Unlike traditional banking, DeFi uses over-collateralization with varying loan-to-value (LTV) ratios. For example:
- ETH typically has 75% LTV
- Stablecoins may have 90% LTV
When collateral value falls below threshold levels, liquidation occurs to maintain system solvency. Liquidators profit from discounted asset purchases during this process.
👉 Learn how to become a DeFi liquidator
Comparative Analysis of Liquidation Mechanisms
1. MakerDAO: Auction-Based Model
- Collateral Ratio: 150% minimum for ETH
Process:
- Dutch auctions for liquidated assets
- 13% penalty applied
- Advantage: Transparent price discovery
- Risk: Slow auctions during volatility
Example: If ETH collateral drops below 150% LTV, the position enters auction with 13% penalty.
2. Compound: Fixed-Rate Liquidations
- Liquidation Threshold: 75% for ETH
Process:
- 50% of collateral liquidated
- 8% fixed penalty
- Advantage: Predictable outcomes
- Challenge: Requires coding skills to participate
3. Aave: Dynamic Penalty System
Safety Features:
- 5% buffer between max borrow (75%) and liquidation (80%)
- Penalties range 5%-15% based on utilization
- Advantage: User-friendly interface for liquidators
- Innovation: Real-time risk monitoring
Key Differentiators
| Protocol | Penalty | Process Speed | User Safety |
|---|---|---|---|
| MakerDAO | 13% | Slow | Low |
| Compound | 8% | Medium | Medium |
| Aave | 5-15% | Fast | High |
FAQs
Q: How can borrowers avoid liquidation?
A: Maintain collateral above required ratios and monitor price movements closely.
Q: Which protocol is best for new users?
A: Aave's built-in safety buffers make it most beginner-friendly.
Q: What's the profit potential for liquidators?
A: Ranges from 5% (Aave) to 13% (MakerDAO) of liquidated positions.
👉 Start earning through DeFi liquidations
Conclusion
While all three protocols serve similar functions, their liquidation mechanisms differ significantly:
- MakerDAO prioritizes decentralization through auctions
- Compound offers predictability with fixed parameters
- Aave leads in user experience and risk management
As the DeFi space evolves, protocols combining speed, transparency, and accessibility like Aave are poised to dominate. Users should understand these mechanisms to make informed participation decisions.