Frictions in DeFi Liquidations: Evidence from the Aave V2 Main Market

Abstract

Lending in decentralized finance (DeFi) relies on collateral and efficient liquidations to manage credit risk. The permissionless and pseudonymous nature of public blockchains precludes reputation-based lending in DeFi and renders liabilities effectively non-recourse. Frictions in collateral liquidations increase the risk of bad debt and may ultimately lead to protocol defaults and losses for liquidity providers. This paper studies liquidation dynamics in the Aave V2 Main Market on Ethereum using block-level data covering 46 months and more than 54 000 borrower positions. While most undercollateralized debt is liquidated almost instantaneously, a non-trivial share of positions remains open for extended periods. Using a state model to distinguish healthy, viable for liquidation, and stale borrower positions, this paper quantifies transition probabilities and identifies factors associated with liquidation success. Logistic regression results show that liquidation size, lower network transaction fees, and relative profitability are associated with the probability of liquidation success in the subsequent block. At the same time, oracle price distortions and asset price volatility are associated with lower liquidation likelihood, consistent with heightened execution risk. The findings provide new high-frequency evidence on liquidation frictions in a large and mature DeFi lending market. The results contribute to the understanding of the microstructure of DeFi liquidations and credit risk in decentralized lending protocols.