diff --git a/crates/redeem/src/lib.rs b/crates/redeem/src/lib.rs
index 2cbccaf2ec..45943d7eb8 100644
--- a/crates/redeem/src/lib.rs
+++ b/crates/redeem/src/lib.rs
@@ -679,7 +679,7 @@ impl<T: Config> Pallet<T> {
             amount_to_slash
         };
 
-        // first update the issued tokens; this logic is the same regardless of whether or not the vault is liquidated
+        // first update the issued tokens
         let new_status = if reimburse {
             // Transfer the transaction fee to the pool. Even though the redeem was not
             // successful, the user receives a premium in collateral, so it's OK to take the fee.
@@ -688,7 +688,14 @@ impl<T: Config> Pallet<T> {
             fee.transfer(&redeem.redeemer, &ext::fee::fee_pool_account_id::<T>())?;
             ext::fee::distribute_rewards::<T>(&fee)?;
 
-            if ext::vault_registry::is_vault_below_secure_threshold::<T>(&redeem.vault)? {
+            if vault.is_liquidated() {
+                // In this situation, tokens are burned and the collateral gets transferred
+                // to the user. This is similar to what happens in a liquidation_redeem.
+                vault_to_be_burned_tokens.burn_from(&redeemer)?;
+                ext::vault_registry::decrease_tokens::<T>(&redeem.vault, &redeem.redeemer, &vault_to_be_burned_tokens)?;
+                // set to Reimbursed(true) such that the vault can't mint the ibtc/kbtc later on
+                Self::set_redeem_status(redeem_id, RedeemRequestStatus::Reimbursed(true))
+            } else if ext::vault_registry::is_vault_below_secure_threshold::<T>(&redeem.vault)? {
                 // vault can not afford to back the tokens that it would receive, so we burn it
                 vault_to_be_burned_tokens.burn_from(&redeemer)?;
                 ext::vault_registry::decrease_tokens::<T>(&redeem.vault, &redeem.redeemer, &vault_to_be_burned_tokens)?;
diff --git a/parachain/runtime/runtime-tests/src/parachain/redeem.rs b/parachain/runtime/runtime-tests/src/parachain/redeem.rs
index d6527cf1dc..16cf7ae147 100644
--- a/parachain/runtime/runtime-tests/src/parachain/redeem.rs
+++ b/parachain/runtime/runtime-tests/src/parachain/redeem.rs
@@ -963,17 +963,15 @@ mod spec_based_tests {
                         // to-be-redeemed decreased, forwarding to liquidation vault
                         vault.to_be_redeemed -= redeem.amount_btc() + redeem.transfer_fee_btc();
                         liquidation_vault.to_be_redeemed -= redeem.amount_btc() + redeem.transfer_fee_btc();
+                        liquidation_vault.issued -= redeem.amount_btc() + redeem.transfer_fee_btc();
 
                         *fee_pool.rewards_for(&vault_id) += redeem.fee();
 
                         // the collateral that remained with the vault to back this redeem is now transferred to the
-                        // liquidation vault
+                        // user
                         let collateral_for_this_redeem = collateral_vault / 4;
                         vault.liquidated_collateral -= collateral_for_this_redeem;
 
-                        *vault.free_balance.get_mut(&vault_id.wrapped_currency()).unwrap() +=
-                            redeem.amount_btc() + redeem.transfer_fee_btc();
-
                         // user's tokens get unlocked
                         (*user.balances.get_mut(&vault_id.wrapped_currency()).unwrap()).locked -=
                             redeem.amount_btc() + redeem.fee() + redeem.transfer_fee_btc();
@@ -1780,10 +1778,12 @@ fn integration_test_redeem_wrapped_cancel_liquidated_reimburse() {
                 // to-be-redeemed decreased, forwarding to liquidation vault
                 vault.to_be_redeemed -= redeem.amount_btc() + redeem.transfer_fee_btc();
                 liquidation_vault.to_be_redeemed -= redeem.amount_btc() + redeem.transfer_fee_btc();
+                // decrease issued tokens on the liquidation vault by the same amount, s.t. the
+                // effective exchange rate (i.e. the one accounting for to_be_redeemed tokens)
+                // of the liquidation vault does not change.
+                liquidation_vault.issued -= redeem.amount_btc() + redeem.transfer_fee_btc();
 
                 // tokens are given to the vault, minus a fee that is given to the fee pool
-                *vault.free_balance.get_mut(&vault_id.wrapped_currency()).unwrap() +=
-                    redeem.amount_btc() + redeem.transfer_fee_btc();
                 *fee_pool.rewards_for(&vault_id) += redeem.fee();
 
                 // the collateral that remained with the vault to back this redeem is transferred to the user