Liquidations and bad debt
When you borrow in Lotus, your loan is healthy only while it stays within the tranche’s risk limits. If your position becomes unhealthy, Lotus allows it to be liquidated. If a liquidation does not recover enough value to fully repay the loan, the remaining shortfall is bad debt.
This page explains what to expect at a high level.
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
Liquidation is the process of repaying some or all of a borrower’s debt using the borrower’s collateral.
At a high level:
A liquidator repays 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 logic (for example, including a discount or incentive).
Different markets can use different liquidation modules. The important point is that the liquidation module defines the rules for 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 are part of the mechanism that protects lenders. They are designed to convert collateral into repayment for the loan token.
However, liquidation does 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 loss handling is designed to stay aligned with risk.
At a high level:
Bad debt is assigned according to the market’s accounting rules.
Losses are expected to be borne by the parts of the market that took the risk that produced the shortfall.
The exact mechanics depend on the market configuration and are covered in Advanced: Protocol math.
Next steps
Read Loan health and LLTV (or the relevant section in Markets and tranches) to understand what makes a position liquidatable.
Read Risk and safety → Oracles to understand how oracle choice affects liquidation behavior.
If you want exact calculations and examples, go to Advanced: Protocol math → Interest and bad debt allocation math.
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