Liquidation
Unpacking the Liquidation Process in Fixed-Rate Lending
Last updated
Unpacking the Liquidation Process in Fixed-Rate Lending
Last updated
This section explains the liquidation process specific to the Fixed-Rate Lending protocol. Note that this differs from the liquidation process involving the Stability Pool in the USDFC Stablecoin protocol.
The liquidation process holds paramount importance for Secured Finance as a Decentralized Loan Protocol, primarily for two crucial reasons:
Mitigating default risk: Through the liquidation process, lenders are safeguarded against the risk of default by borrowers. When a borrower's collateral value falls below the liquidation threshold relative to their debt, their loan becomes eligible for liquidation, ensuring the lenders can recover their funds.
Maintaining protocol stability: The liquidation process plays a pivotal role in preserving the stability of the DeFi loan protocol. It prevents the accumulation of undercollateralized loans. Excessive loan defaults can deplete the protocol's reserves, potentially leading to system instability. By executing liquidations, the protocol can maintain a healthy balance and ensure its overall stability.
When the borrower's ratio surpasses the defined , the borrower's position (collateral) becomes subject to liquidation.
During a liquidation process:
A portion of the borrower's outstanding debt (up to 50%) is repaid using their deposited collateral.
The amount of collateral seized is equal to the value of the debt being repaid plus a .
Liquidations are typically executed by third-party who are incentivized to perform this action.
The Loan to Value (LTV) ratio compares the value of a borrower's debt to the value of their collateral.
LTV = (Value of Debt / Value of Collateral) * 100%
A higher LTV indicates a higher risk of liquidation. The platform visualizes this risk:
Green: Low risk
Yellow: Moderate risk
Red: High risk (approaching liquidation threshold)
The liquidation threshold is the LTV percentage at which a borrower's position becomes eligible for liquidation.
Current Threshold: 80% for all currencies.
Dynamic Adjustment: This threshold may be adjusted based on market conditions (volatility, liquidity) for specific assets.
Over-Collateralization: Borrowers must initially deposit collateral worth significantly more than their loan amount to provide a safety buffer.
A penalty is applied during liquidation to compensate the liquidator and contribute to the protocol's reserve fund.
Current Penalty: 7% on the value of the collateral being liquidated.
Borrowers should actively manage their collateral levels to avoid liquidation and the associated penalty.
The value of collateral is determined using real-time price feeds, primarily from Chainlink. The protocol uses principles based on recent trading activity (VWAP) where available, falling back to oracle prices if necessary.
See a detailed example in the . Learn more about the role of liquidators in .
