Curve's soft liquidation mechanism allows hundreds of DeFi loans to remain underwater for extended periods.
DeFi & Yields ·
Curve's soft liquidation mechanism, which gradually closes positions rather than forcing immediate sales, has allowed hundreds of DeFi loans to remain underwater for extended periods. This design, inspired by the protocol's LLAMMA lending–liquidation AMM, enables collateral to self-hedge before liquidation thresholds are breached, creating a gentler slope than traditional cliff-edge liquidations.
The mechanics differ sharply from conventional systems where margin shortfalls trigger instant asset sales. Instead, soft liquidation adjusts risk continuously onchain, permitting borrowers time to restore health factors or exit gracefully as collateral prices fluctuate. The tradeoff is extended exposure: rather than a rapid wipeout, loans can linger in distressed states for weeks.
The duration and scale of these underwater positions—whether they pose systemic risk, who ultimately absorbs losses, and whether lenders are adequately compensated for the extended holding period—remain open questions. No data yet clarifies how many of the affected loans eventually recovered versus how many ultimately defaulted.