Liquidations

Introduction

Liquidation is a mechanism triggered when a borrower's health factor dips below 1, indicating that the value of their collateral no longer adequately covers their outstanding loan. Such a scenario can arise if the collateral's value diminishes or if the borrowed amount appreciates in comparison. This ratio of collateral to loan value is represented by the health factor.

During a liquidation, up to 50% of a borrower's outstanding debt is settled, and the equivalent value, inclusive of the liquidation fee, is deducted from the borrower's collateral. Thus, the portion of the debt that's liquidated is effectively settled.

How much is the liquidation penalty?

The liquidation penalty, which serves as a bonus for liquidators, varies based on the collateral asset. Specific liquidation fees for each asset can be found in the risk parameters section.

Liquidation examples:

Here are a couple of scenarios:

Example 1: Alice deposits 100 XLM and takes out a loan equivalent to 50 XLM in USDC. Should Alice's Health Factor fall below 1, her loan becomes susceptible to liquidation. A liquidator has the option to settle up to 50% of the borrowed sum, which is 25 XLM in USDC. In exchange, the liquidator receives a portion of the collateral, in this case, XLM, with a 5% bonus. Thus, the liquidator gets 25 + 1.25 XLM for settling a debt of 25 XLM in USDC.

Example 2:

Alice deposits 50 XLM and wETH equivalent to 40 XLM, and borrows USDC worth 50 XLM. If Alice’s Health Factor drops below 1, her loan becomes eligible for liquidation. A liquidator can repay up to 50% of the borrowed sum, which is 25 XLM in USDC. Given that wETH offers a higher liquidation bonus (15%) compared to XLM (5%), the liquidator opts for wETH. The liquidator receives wETH worth 25 + 3.75 XLM for settling a debt of 25 XLM in USDC.

How can I avoid liquidation?

To safeguard against liquidation, you can bolster your health factor by either adding more collateral or settling a portion of your debt. Typically, repayments elevate your health factor more effectively than deposits. It's crucial to keep a close watch on your health factor, ensuring it remains sufficiently high to ward off liquidation. Maintaining a health factor above 2, for instance, offers a safety buffer against liquidation.

It's also vital to be cognizant of potential price fluctuations in stablecoins due to market dynamics. For instance, while the nominal value of USDC is $1.00, market forces might value it at $0.95. Such price variations, like with all assets, impact your health factor. Further insights on price determinants can be found in the price discovery section.

Can I engage in the liquidation ecosystem?

Absolutely. While the liquidation process is open to all, it's a competitive arena. Typically, liquidators employ bespoke solutions and automated bots to gain an edge, ensuring they're the first to liquidate loans and secure the associated bonuses.

If you have further questions or encounter any issues, don't hesitate to contact the AssetDesk team through our Discord or Telegram channel.