What Are Soft Liquidations?

How Soft Liquidations Work

• Gradual Conversion: When the value of a borrower's collateral starts to decline and approaches a risky level, instead of immediately selling off all collateral (hard liquidation), the protocol automatically and gradually converts the collateral into the borrowed asset. If the collateral value begins to climb, this process is reversed (a process called de-liquidation)12.
• Within a Range: Soft liquidation occurs within a specified price band or range. The deeper the asset price falls within the band, the more of the collateral is converted.
• Fee Impact: Throughout this process, some losses accrue to the position due to trading fees from these conversions. If the health of the loan continues to deteriorate and reaches a critical threshold, a hard liquidation (full collateral sell-off) is triggered.

Why Use Soft Liquidations?

• Reduces Liquidation Risk: This mechanism acts like an automated warning and response system, giving borrowers a chance to recover their position if the market rebounds before a hard liquidation sets in.
• Smoother Market Impact: By selling gradually rather than all at once, soft liquidations reduce sudden market impacts and slippage, which benefits both borrowers and the protocol.
• Examples in Practice: Curve's LLAMMA model for crvUSD implements soft liquidations. As a collateral asset's price falls, collateral is linearly sold for the borrowed asset; as it rises, the action reverses. This reduces “bad debt” risk and gives borrowers more reaction time compared to abrupt, traditional liquidations123.
• Distinction from Hard Liquidations: Hard liquidations immediately liquidate remaining collateral when the position health hits zero, typically at a steeper penalty. Soft liquidations are the gentler, initial defense.

Important Notes

• Collateral loss in soft-liquidation mostly comes from swap/trading fees, not outright capital forfeiture.
• If market volatility is high, health can erode faster, possibly accelerating transition to hard liquidation.
• Repaying debt during soft-liquidation improves position health but the soft-liquidation range persists until the risk level normalizes13.

Real-World Example