How to avoid liquidation when borrowing against crypto

Borrowing against your crypto assets is a brilliant way to obtain on-demand capital and maintain your exposure to the market at the same time. Crypto lending platforms simplify this process through innovative automation, making it significantly easier than traditional lending. However, it exposes investors to greater risk due to the volatility of crypto assets.

While borrowing against crypto, be intentional about avoiding liquidation. Liquidation is meant to protect a lender from bad loans, but for borrowers, it means losing their collateral. Most crypto loans are overcollateralized, meaning that liquidations result in losses significantly higher than the amount borrowed. Therefore, protecting yourself from liquidation is a no-brainer.

Avoiding liquidation when borrowing against crypto

The general rule for staying safe from liquidation is to maintain an LTV ratio below the lender’s liquidation threshold. Here are some tips for avoiding liquidation when borrowing against crypto;

Understand Your Platform’s Specific Thresholds

Lending platforms operate remarkably different liquidation systems. While the basic procedure may be the same, there may be specifics. Liquidation threshold is one of the usual variables. For instance, the liquidation threshold for bitcoin-backed loans on Clapp Finance is 90%. The liquidation threshold specifies the LTV at which your collateral is liquidated. Before applying for a loan on any platform, verify the liquidation threshold and how it changes over time.

Ensure that you understand this and any other applicable terms. As a rule of thumb, maintain an LTV ratio significantly below the platform’s liquidation threshold for your collateral asset and only use platforms whose liquidation terms are clearly documented.

Maintain a very conservative LTV ratio

The LTV ratio for your loan depends on the value of your collateral asset and the amount borrowed. When the market price of your collateral asset declines, the LTV ratio rises. You risk liquidation if the value of the collateral asset declines at an abnormal rate. For crypto assets, this is usual during market crashes.

To prevent liquidation, it is recommended that you maintain an LTV ratio that keeps you safe from unexpected price movements. An LTV ratio of 10% to 30% is regarded as the safest for volatile assets. You may go as high as 40% for more stable assets. However, note that a higher LTV ratio increases your risks of liquidation.

Here’s a tabulated guide for LTV ratio vs safety from liquidation

Monitor Actively and Set Alerts

Closely monitor your loan position to avoid liquidation. Depending on the volatility of your collateral asset, we recommend checking the LTV ratio at least twice a day. Set price and liquidation alerts below your liquidation points to notify you before your loan health declines below the liquidation threshold. For instance, if liquidation is at 80% LTV, set alerts at 55–65% LTV. Use platform notifications, external tools (such as price trackers and on-chain monitors), or third-party apps that track health factors to monitor your position.

Keep a maintenance reserve and be proactive

One way to avoid liquidation is to repay your loan or increase your collateral to reduce the LTV ratio. In both scenarios you need a readily available reserve. We recommend a collateral or stablecoin reserve of up to 40% of your loan position. This gives you enough leverage in case of unexpected volatility. As mentioned earlier, keep a close monitoring of your position and be proactive; do not wait until your health deteriorates before acting. If possible, have a written action plan in advance, for instance, “If BTC drops 20%, I will add X collateral or repay Y”.

Additional Risk Management Strategies

Here are some secondary risk management strategies you can apply

Cross-platform diversification: You can derisk your loan by splitting your borrowing across different platforms. Consider combining centralized and decentralized platforms to leverage their distinct structural and UX differences.

Borrow with stablecoins or less volatile assets: Stablecoins and significantly less volatile assets do not fluctuate like regular cryptocurrencies. Therefore, it’s unlikely to trigger a dramatic liquidation during general market crashes. Summarily, avoid borrowing against memecoins, new cryptocurrencies, and assets with a history of flash crashes.

Avoid over-leveraging: Do not borrow excessively from your credit line or fixed loan. It is recommended that you borrow less than the approved amount and avoid threading close to the full approved amount. Maintain a cultured borrowing strategy and abide by it. Treat borrowing as a long-term tool, not a way to maximize leverage.

Conclusion

Like crypto investing, borrowing with crypto is a strategic move. While borrowers adopt different strategies to boost profitability, the consequences of a bad loan are the same. Therefore, regardless of your strategy and reason for borrowing, maintaining a healthy loan is important. We discussed a few strategies for avoiding liquidation and recommend that you consider them alongside your personal lending and safety strategies. Keep in mind that the risks associated with crypto investing apply to lending, in addition to the inherent risks of lending. Therefore, the safety of your capital is paramount.