The decentralized‑finance boom is back in high gear. Lending protocols alone now safeguard more than $33 billion in deposits spread across Ethereum, Solana and a dozen Layer‑2 networks. That’s serious capital—roughly the GDP of a midsize country—sitting in smart contracts that can be margin‑called in milliseconds.
But with yield comes peril. On April 7, a violent 14 percent slide in XRP and Sol sparked a chain reaction that wiped $800 million in leveraged crypto positions off the map in a single afternoon, a reminder that even blue‑chip tokens can trigger liquidation cascades when markets choke on sudden volatility.
Smaller names aren’t immune either. Just last week, Mantra’s OM token plunged more than 90 percent within hours after a handful of oversized positions were forcibly liquidated across multiple venues—$65 million on Binance alone—sending shock waves through Telegram trading desks.
Sometimes the threat hides in plain sight. On April 20, Ethereum lending stalwart Aave showed $120 million in ETH collateral sitting right at its 80 percent liquidation threshold, meaning a modest dip below $2,500 would have flushed that ether onto the open market.
Traders watching the DeFi Risk Radar described it as “a loaded mousetrap” waiting for one bearish headline.
In other words, liquidation risk isn’t an edge‑case footnote—it’s the beating heart of DeFi’s biggest successes and most spectacular wipeouts.
Whether you’re a casual yield farmer or a fund running nine‑figure books, understanding how to sidestep those traps is no longer optional. It’s the difference between compounding gains in a permissionless future and watching your collateral disappear faster than you can refresh Etherscan.
Before we get into the details of avoiding or minimizing DeFi liquidations let's first understand what it is and how it works.
What is DeFi Liquidation?
In simple terms, liquidation is the process of not being able to hold a leverage position because of the absence of sufficient funds.
Crypto traders face liquidation when they are unable to fulfil the margin requirements for leveraged positions which essentially means they have run out of funds to keep the trades open. To avoid this you need to have critical strategies in place while you trade so that you can leverage them in future.
In Decentralized Finance (DeFi) traders access borrowing agreements outside of traditional finance by putting up crypto assets as collateral. But, they have to remember the volatile nature of digital assets which can often lead to liquidation of their agreements. In such a situation, traders lose their collateral which heightens the risks of the DeFi space and the trader.
DeFi liquidation happens when the borrower’s collateral mentioned in the agreement goes below a particular threshold, making it a risky position for both parties because of crypto market volatility. To lower the risk of DeFi liquidation, traders need to maintain a margin between asset borrowing and their collateral.
Ways to Avoid DeFi Liquidation
The volatile nature of the crypto market makes it difficult to accommodate slight variations in the price, which leads to liquidation and losses. To counter this and ensure that DeFi liquidation risks are curtailed, traders need to opt for certain strategies.
Build a proper trading plan
The first and foremost strategy is to plan your trades ahead of time to reduce liquidation chances. This includes devising a plan that takes into account losses in case of liquidation and a proper exit strategy when the market goes down.
This will prevent impulsive buying due to greed or fear emotions, removing any temptation to retain positions for too long. All this makes traders exit the game when it is time not too soon without any leveraging much profits.
Secure trading positions
The crypto market is always up for fluctuations and despite the best precautions the price can go in unintended directions. Hence, traders need to align their trading positions along the price chart such that they have an exit strategy which prevents liquidating their position if the market goes the opposite way.
For this crypto traders mark a range or level where they can exit the trade. However, this alone isn’t enough it’s feasible to use a stop-loss order to make the exit plan more effective in reducing losses
This stop-loss order is the exact price where a trade will automatically exit if the cryptocurrency goes down to a pre-determined level. However, stop-loss orders are not a foolproof solution to protect against liquidation. In case, the liquidation price fluctuates then stop-loss orders might fail to prevent liquidation.
Maintain the margin
As mentioned earlier the key to mitigating DeFi liquidation risk is to maintain the margin which is the minimum amount needed to keep the trade open. There’s also a margin balance which shows the funds available in the account.
When the margin balance goes below the maintenance margin the crypto exchange will automatically close the leveraged positions in order to restrict losses. Hence, crypto traders should maintain the margin to avoid liquidations.
When a price declines significantly, traders need to maintain enough margin balance to keep the trade open. The higher the margin balance, the lower is the liquidation price.
Practice your trading
Traders should familiarize themselves with mock trading where they test their trading tools and strategies and gain experience. Testnets are useful in this regard as they provide the opportunity to practice in real-time without risking capital.
Proper utilization of risk management strategies
Risk management is a key aspect of crypto trading and one of the essential strategies to manage risks is to limit exposure on any particular trade. Traders shouldn’t risk over 1-2% of their trading account balance on a single trade.
If the trader has $10,000 balance in their account then they shouldn’t risk more than $100-200 per trade as they will lose only a small portion if it goes wrong. Ideally, it is best to leverage 2x-5x and avoid getting into multiple trade contracts.
Large positions where 1-2 bad trades can wipe out balances are best avoided instead it is better to start slow and develop a method of trading that doesn’t involve large positions.
Restrict compounding losses
Traders should restrict investing in positions that are losing trade. Say they have invested in a contract whose value is on the decline, it is wise not to invest further in the same contract.
Investing in losing positions reduces the liquidation price and increases the potential for liquidations. Traders should instead think of cutting losses by shutting down losing positions and focusing on lowering risks. They can also avoid liquidation by adding more contracts or averaging down.
Avoid Overtrading
Overtrading or constantly indulging in buying and selling to make profit often act as a trap for liquidation as it leads to high trading costs. Hence, traders need to develop a proper trading strategy and stick to it to prevent excessive trading and getting swayed by market emotions.
Reduce blindly following hotspots
Lastly, crypto traders should do their own research and follow a trading plan instead of blindly following hotspots and investing in popular trades to make profits. This blind following of trends results in heightened risks, making them lose their rationality and power of choosing. Instead, conduct thorough research to identify trading opportunities and devise a proper trading plan to gain profits.