Liquidation

Overview

When borrowing assets on the money market, if the price of the asset one is borrowing moves against them, the value of their collateral may fall below the required over-collaterization level, triggering a liquidation. At this point, the borrower must either deposit additional collateral or have their position liquidated to repay the lender.

Liquidations occur when a user’s Loan to Value (LTV) ratio exceeds the position's Liquidation Threshold (LT). This can happen when:

• The value of the collateral asset deposited depreciates compared to the value of the asset borrowed;

• The value of the asset borrowed appreciates relative to the value of the asset supplied as collateral;

• A user’s borrow interest accrues to the point that the amount owed exceeds the liquidation threshold.

How It Works

When a position is considered unviable (LTV < LT), they are open to being liquidated. On Demex anyone can participate in liquidations. Users must have enough assets to repay the position’s debt to liquidate their collateral.

Liquidation Threshold

The Liquidation Threshold (LT) is the LTV ratio at which a position is defined as under-collateralized and a borrower should expect to be liquidated.

Example

Assuming USDC has a Liquidation Threshold of 88%, and the value of ATOM remains constant:

A user provides $1,000 USD worth of USDC and borrows the maximum allowable amount of $850 worth of other assets (85% LTV). The value of the borrowed assets increases to $950, bringing the user’s LTV ratio to 95% (thus exceeding the Liquidation Threshold of 88%). The borrower will be liquidated in order to ensure their position remains over-collateralized.

For each wallet, the Liquidation Threshold is calculated as the weighted average of the Liquidation Thresholds of the collateral assets and their value:

$$Liquidation\hspace{0.1cm} Threshold = \frac{Σ Collateral_{i} \hspace{0.1cm}in \hspace{0.1cm}USD*Liquidation\hspace{0.1cm}Threshold_{i} }{Total \hspace{0.1cm}Collateral\hspace{0.1cm} in \hspace{0.1cm}USD }$$

Liquidation Discount

When liquidating a position, liquidators the amount of collateral the liquidators get is equal to the value of the loan they repaid, multiplied by a Liquidation Discount.

In other words, the Liquidation Discount is a pricing differential for the actual market price of the collateral assets that is used when liquidators repay a position that has HF < 1.

Since a position does not need to be completely liquidated at once, the amount of earnings a liquidator gets is given by:

LiquidationBonus = LiquidationDiscount x Amount of collateral liquidated

The penalty borne by liquidated borrowers is therefore given by the bonus earned by liquidators.

Liquidation Penalty for Borrowers

The Liquidation Penalty is the fee paid by a borrower to the Liquidators, in the event that they are liquidated. When a liquidation occurs, a portion of the assets being used as collateral will be used to pay off the outstanding loan plus the Liquidation Penalty.

Borrowers should always try to ensure that their positions remain properly over-collateralized in order to avoid paying a Liquidation Penalty.

Example If a debt of 1,000 USDC is liquidated and the Liquidation Penalty is 5%, the borrower should expect to have 1,050 USDC worth of collateral liquidated.

Liquidation Bonus for Liquidators

By returning a borrower's debt, the liquidator can seize the position’s collateral amounting to the repaid debt’s value at a Liquidation Bonus.

The Liquidation Bonus is being imposed so that there is an incentive for users to compete in securing this “free” profit, in turn helping the protocol quickly unwind unviable positions during the buffer range before the loan goes into deficit.

Since the collateral is valued at a discount during liquidation, the total value the liquidator receives after the liquidation would be more than the value they transferred in. The liquidator can then pocket this difference (also known as the “Liquidation Bonus”) as profit.

This incentivizes liquidators to quickly repay risky positions and reduce the protocol's overall risk.

The Liquidation Discount for each assets are independent and vary based on their respective liquidity risk. This is as assets that are more volatile require higher liquidation discounts, as liquidators may suffer more slippage when converting out of the collateral asset that they have acquired

You can find every assets' Liquidation Discount on the explorer.

Liquidation Fees

A 10% Liquidation Fee is imposed on the Liquidation Bonus for all assets, which accrues to stakers.

Example

The Liquidation Discount for ATOM is set at 5%. Out of this the amount earned due to the discount,

• 10% is charged as Liquidation Fee and goes to stakers

• Remaining 90% goes to the liquidators