Liquidations and Bad Debt
A loan is healthy only while it stays within the tranche's risk limits. If a position becomes unhealthy, Lotus allows it to be liquidated. If liquidation does not recover enough value to fully repay the loan, the remaining shortfall is bad debt.
When liquidation can happen
A position can be liquidated when it fails the tranche’s loan health check. In most markets, that health check depends on:
the value of your collateral (from the tranche’s oracle)
how much you borrowed (including accrued interest)
the tranche’s LLTV
If the loan crosses the LLTV threshold, it becomes eligible for liquidation.
What happens during liquidation
A liquidator repays some or all of the borrower's loan token debt.
The protocol transfers collateral from the borrower to the liquidator.
The collateral amount is determined by the tranche's liquidation module (e.g., including an incentive).
Each market can use a different liquidation module, which defines how liquidations are priced and executed.
What liquidation means for you
If you borrow
If your position is liquidated:
your debt is reduced (partially or fully repaid)
your collateral is reduced (sold or transferred)
you may lose more collateral than you expect if prices move quickly or liquidity is thin
To reduce liquidation risk:
keep a buffer below the LLTV
monitor your collateral price and your debt growth (interest accrual)
repay or add collateral before you approach the threshold
If you lend
Liquidations protect lenders by converting collateral into loan token repayment, but they do not guarantee full recovery in every scenario.
What is bad debt?
Bad debt is debt that remains after liquidation when the collateral is not enough to repay what is owed.
Bad debt can occur for reasons such as:
rapid price moves that outrun liquidation execution
oracle lag or incorrect pricing
insufficient liquidity to sell collateral efficiently
liquidation module limitations under stress
How bad debt is handled
Lotus tracks debt and collateral by tranche, so losses stay aligned with the risk that produced them. Bad debt is assigned according to the market's accounting rules — the tranches that backed the defaulted position absorb the shortfall. The exact mechanics are covered in Advanced: Protocol math.
Pre-liquidation
Lotus also supports pre-liquidation, which allows partial liquidation before the LLTV threshold. When a position enters the pre-liquidation zone (between a configurable PRE_LLTV and the LLTV), liquidators can partially close it with a smaller incentive — giving borrowers a soft landing and reducing the risk of bad debt. See Pre-Liquidation for details.
Next: Read about how lending is simplified with Lotus Vaults.
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