Liquidations

In decentralized finance, lending protocols such as Maker and Aave offer a significant opportunity for Miner Extractable Value (MEV) through liquidations. These platforms require users to deposit collateral, like ETH, which can then be used to lend assets to others. Borrowers can leverage their collateral to borrow up to a certain percentage of its value, as determined by the protocol. For example, with a borrowing limit set at 30%, depositing 100 DAI allows a user to borrow up to 30 DAI worth of other assets. This collateralization ensures the protocol's solvency and limits the borrowing capacity based on the collateral's value.

The MEV opportunity arises when the value of a borrower’s collateral declines due to market fluctuations, causing the borrowed amount to exceed the permissible limit. If, for instance, the borrowed assets surpass 30% of the collateral's value, the protocol allows for liquidation. This mechanism is similar to a margin call in traditional finance, where the borrower must either repay the loan or face liquidation of their collateral. In DeFi, anyone can initiate the liquidation process, covering the borrowed amount and receiving a portion of the liquidation fee as a reward. This fee serves as an incentive for liquidators to act swiftly, ensuring the protocol's stability by repaying the lenders promptly.

MEV searchers, therefore, compete intensely to identify liquidation opportunities by rapidly parsing blockchain data. Their goal is to be the first to submit a liquidation transaction, thereby securing the liquidation fee. This competition drives the need for sophisticated algorithms and real-time monitoring to detect fluctuations in collateral values and execute liquidation transactions efficiently, maximizing the profit potential from these opportunities.