Ethereum (ETH): how DeFi liquidation cascades impact ETH price

Discover how liquidations in Ethereum‑based DeFi protocols can trigger cascading sell‑offs, influence ETH’s market dynamics, and what this means for retail investors in 2025.

• Liquidation mechanics on Ethereum can amplify price swings across the whole ecosystem.
• Understanding these cascades helps investors anticipate volatility and protect positions.
• The article explains the chain reaction, real‑world examples, and practical safeguards.

Ethereum’s prominence as the backbone of decentralized finance (DeFi) has grown into a multi‑trillion‑dollar industry. Yet with great scale comes systemic risk: when borrowers fail to maintain collateral ratios, liquidators seize assets, which can trigger further liquidations in a chain reaction.

The core question this article tackles is how these liquidation cascades affect ETH’s price and why retail investors should pay attention. We’ll break down the mechanics, explore recent 2025 events, assess risks, and look ahead at potential scenarios.

For crypto‑intermediate retail investors who are already comfortable with spot trading but new to DeFi lending protocols, this deep dive will provide actionable insights into how ETH’s price can be dragged by collateralized debt positions (CDPs) on platforms like Aave, Compound, and MakerDAO.

Background: Liquidations in Ethereum‑Based DeFi

In DeFi, borrowers lock up collateral—typically ETH or other tokens—to borrow stablecoins such as USDC. The borrowing power is governed by a liquidation threshold set by the protocol. If market volatility pushes the collateral’s value below this threshold, automated liquidators are triggered to sell the collateral and repay the debt.

Ethereum’s dominance stems from its robust smart‑contract infrastructure, high liquidity, and widespread developer adoption. As of early 2025, the combined TVL (total value locked) in major lending protocols exceeded $120 billion. This concentration means that a single large liquidation event can ripple through multiple platforms.

Key players include:

• Aave: A permissionless, non‑custodial protocol that offers over 50 collateral types.
• Compound: Pioneered the “interest‑earning” token model and introduced governance tokens (COMP).
• MakerDAO: The first DeFi stablecoin system, where DAI is minted against ETH collateral via CDPs.
• Layer‑2 solutions such as Arbitrum and Optimism, which have their own lending ecosystems, adding cross‑chain complexity.

How Liquidation Cascades Work: A Step‑by‑Step Breakdown

The liquidation cascade is a self‑reinforcing loop that can quickly move from a single trigger to a market-wide selloff. Here’s how it unfolds:

1. Trigger event: ETH price drops 5–10% in a short period, reducing the collateral value of borrowers below the liquidation threshold.
2. Automated liquidator bots scan for under‑collateralized positions and execute sell orders on exchanges or within protocol markets.
3. Market impact: Each sale adds supply pressure to ETH and other tokens, pushing prices down further.
4. Secondary liquidations: The price dip causes more borrowers to fall below thresholds, triggering additional liquidations—a feedback loop.
5. Stabilisation or runaway: If the market absorbs the selling pressure (e.g., through liquidity providers stepping in), prices may rebound. Otherwise, a runaway cascade can lead to a sharp crash.

Smart contracts enforce these rules without human intervention, which is both an efficiency and a vulnerability. The speed of liquidation—often within seconds—means that price data on decentralized exchanges (DEXs) may lag behind the actual market conditions, amplifying slippage for liquidators.

Market Impact & Use Cases

Liquidation cascades can have several direct and indirect effects on ETH’s price:

• Price volatility spike: In 2025, a coordinated liquidation event on Aave and Compound pushed ETH from $1,800 to $1,550 in under an hour.
• Liquidity drain: Market makers on Uniswap and Sushiswap reported a 35% increase in withdrawal volumes during the cascade.
• Cross‑protocol contagion: Since many protocols share the same liquidity pools, a sell pressure on ETH can affect yield farming rewards across DeFi.
• Real‑world implications: Institutions holding significant amounts of leveraged positions risk margin calls, potentially forcing them to liquidate other assets.

Below is a simplified comparison between traditional lending and DeFi collateralized borrowing:

Risks, Regulation & Challenges

While DeFi offers high efficiency, it also introduces new risk vectors:

• Regulatory uncertainty: The SEC’s evolving stance on securities classification could classify certain yield‑bearing tokens as securities, imposing stricter compliance.
• Oracle reliability: Liquidation thresholds depend on price feeds. If an oracle is manipulated or delayed, liquidations may trigger incorrectly.
• Smart contract bugs: Vulnerabilities in borrowing contracts can be exploited, leading to unauthorized liquidations or fund drains.
• Liquidity constraints: In a sharp selloff, liquidity providers may withdraw funds, exacerbating price drops.
• KYC/AML gaps: While on‑chain transparency is high, identity verification is often lax, raising concerns for regulators and institutional participants.

A realistic scenario: an oracle hack causes false low prices, triggering a wave of liquidations that wipe out significant TVL across multiple protocols. Even if the underlying asset’s fundamentals remain stable, the market may take time to recover due to loss of confidence.

Outlook & Scenarios for 2025+

Bullish scenario: Improved oracle technology (e.g., multi‑oracle aggregation), stronger regulatory clarity, and higher liquidity provision could reduce the frequency and severity of cascades. ETH price may stabilize around $1,900–$2,200 with tighter volatility bands.

Bearish scenario: A large-scale oracle failure or coordinated attack on major lending protocols could trigger a systemic collapse, pushing ETH below $1,400. Institutional withdrawals might accelerate the downturn.

Base case: Over the next 12–24 months, we expect moderate volatility with occasional cascade events tied to macro‑economic shocks (e.g., inflation spikes). Retail investors who monitor collateral ratios and protocol health indicators will likely navigate these swings more effectively.

Eden RWA: Tokenizing French Caribbean Luxury Real Estate

Amidst the volatility of DeFi, real‑world assets (RWA) offer a counterbalance by providing tangible income streams. Eden RWA is a prime example of how blockchain can democratise access to high‑end property markets.

Eden RWA tokenises luxury villas in Saint‑Barthélemy, Saint‑Martin, Guadeloupe, and Martinique through ERC‑20 tokens representing fractional ownership in SPVs (SCI/SAS). Investors receive periodic rental income paid in USDC directly to their Ethereum wallets. The platform employs DAO‑light governance, allowing token holders to vote on renovations, sale decisions, or property usage.

Key features:

• Transparent yield: Rental income is distributed automatically via smart contracts, with real‑time reporting of cash flows.
• Experiential layer: Quarterly bailiff‑certified draws grant token holders a free week in the villa they partially own, adding utility beyond passive income.
• Liquidity roadmap: A forthcoming compliant secondary market aims to enhance liquidity for token holders, while maintaining regulatory compliance.
• Security stack: Ethereum mainnet deployment, audited contracts, and wallet integrations (MetaMask, WalletConnect, Ledger).

If you’re interested in exploring a stable‑income RWA investment that leverages the Ethereum ecosystem, Eden RWA’s presale offers an opportunity to acquire property tokens before they hit secondary markets.

Learn more about the presale and how you can participate:

Eden RWA Presale – Official Site

Join the Eden RWA Presale Now

Practical Takeaways for Retail Investors

• Track collateralization ratios on major lending protocols to anticipate potential liquidations.
• Monitor oracle providers and protocol upgrades that may affect liquidation thresholds.
• Diversify across assets: pair DeFi exposure with RWAs like Eden RWA to reduce correlation risk.
• Stay informed about regulatory developments affecting smart contract compliance.
• Use portfolio dashboards that aggregate on‑chain data for real‑time insights.
• Consider setting stop‑loss orders if you hold large leveraged positions in DeFi protocols.
• Engage with community governance to influence protocol risk parameters.
• Regularly audit smart contracts and ensure they are audited by reputable firms.

Mini FAQ

What triggers a liquidation on Ethereum?

A liquidation is triggered when the value of collateral falls below the protocol’s predefined threshold, usually due to price volatility or changes in interest rates.

Can I avoid liquidations by keeping a higher collateral ratio?

Yes. Maintaining a buffer above the minimum requirement reduces the risk of automatic liquidations during market swings.

How does an oracle affect liquidation safety?

Oracles provide price data to smart contracts. Reliable, multi‑source oracles reduce the likelihood of false liquidations caused by inaccurate feeds.

What is a “cascading” liquidation?

A cascading liquidation occurs when one liquidation event lowers asset prices enough to trigger additional liquidations across multiple positions, creating a chain reaction.

Is investing in RWA safer than DeFi lending?

RWA investments often have tangible assets and regulated income streams, but they also bring legal ownership complexities. Diversification can mitigate risk from both spaces.

Conclusion

The interconnectedness of Ethereum‑based DeFi protocols means that a single liquidation event can ignite a cascade, exerting significant downward pressure on ETH’s price. For retail investors, understanding these dynamics—through monitoring collateral ratios, oracle reliability, and protocol governance—is essential for managing risk.

As the ecosystem matures, mechanisms such as improved oracle designs, stricter regulatory frameworks, and diversified asset classes like tokenised real estate (e.g., Eden RWA) may temper volatility. Nevertheless, liquidity providers and borrowers should remain vigilant: the speed of automated liquidations leaves little room for human intervention during a cascade.

Disclaimer

This article is for informational purposes only and does not constitute investment, legal, or tax advice. Always do your own research before making financial decisions.