After the almost 40% drop in the value of cryptocurrencies in recent days, many investors are turning their attention to whether side effects might occur. With the growing popularity of stable coins, such as DAI, liquidating your guarantees is easier than ever.
MakerDAO, another of the biggest DeFi protocols had its highest settlement mark yet on Friday – 95. Since this is still relatively low, it may be a good time to consider joining MakerDAO as you would with other decentralized crypto projects.
The focus of investors is now on the impact of this plunge in value on leverage. Since November, when cryptocurrencies hit an all-time high, they have seen a 45 percent crash. The company that provided the collateral for borrowing has been liquidating it as fast as possible to prevent losing everything due to everyone trying get out at once.
Data from The Defiant Terminal shows that on Jan. 23 there were 1,692 liquidations on Aave, by far DeFi’s most important protocol. That’s the highest number since the crash in May 2021.
Another of DeFi’s largest protocols, MakerDAO, also achieved a local high on Jan. 22 with 95 liquidations. Like Aave, that was the protocol’s highest mark since late May.
The number of Aave liquidations was higher than that of Maker, but the dollar value of those liquidations was lower — the Defiant Terminal reports that Maker hit $118.8M in liquidations on Jan. 21, while Aave hit $61.13M during the same period.
As of Jan. 21, over $600M of ETH was at risk of liquidation, according to Maker protocol founder Rune Christensen, who tweeted about the liquidation on Twitter. The $600M of ETH wasn’t all liquidated in the run on Jan. 21, but it was the highest value liquidation on Maker in the past year.
Liquidation in the context of this selloff is important since it represents a major test of DeFi’s functionality under stress. While DeFi users have been rocked by liquidations in the past week, the service has continued to function as intended, which indicates that its utility could remain intact in the long run.
DeFi Liquidation – What’s the Deal?
Users who borrow against their collateral using DeFi protocols like Aave and Maker make themselves vulnerable to liquidation.
These lending protocols enable users to borrow assets, such as Maker’s USD-pegged stablecoin DAI, in exchange for assets such as Ethereum.
There is a limit to what users can borrow based on their collateral. One of Maker’s most popular vaults offers a maximum collateralization of 145%, which means users can deposit up to $68,966 of DAI against $100,000 in ETH before getting liquidated.
Leveraged crypto positions are often financed by borrowing. Leverage on ETH can be accomplished by depositing ETH into Maker, borrowing DAI against that ETH, and then transacting that DAI back into ETH, essentially growing their stack of the cryptocurrency in exchange for Maker’s interest rate and liquidation risk.
Major liquidity crisis
Furthermore, the plunge in token values themselves may exacerbate liquidations and put further pressure on the space. The price of Ethereum fell 25% last week to $2,401, a level not seen since July when the crypto was recovering from a severe sell-off.
CoinGecko reports that the value of all major Layer 1 (L1) smart contract platforms has fallen by a fifth in the last week, too – in fact, all major platforms have lost five percent in the last seven days.
Terra’s LUNA, however, is down 16.9% in that time period, while Cosmos’ ATOM, arguably a Layer 1 platform but not classified by CoinGecko as a smart contract platform, is also down 8.2%.
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Author
Chris Munch is a professional cryptocurrency and blockchain writer with a background in software businesses, and has been involved in marketing within the cryptocurrency space. With a passion for innovation, Chris brings a unique and insightful perspective to the world of crypto and blockchain. Chris has a deep understanding of the economic, psychological, marketing and financial forces that drive the crypto market, and has made a number of accurate calls of major shifts in market trends. He is constantly researching and studying the latest trends and technologies, ensuring that he is always up-to-date on the latest developments in the industry. Chris’ writing is characterized by his ability to explain complex concepts in a clear and concise manner, making it accessible to a wide audience of readers.
