Liquidation Case Study
Understanding the liquidation process through practical examples in the Fixed-Rate Lending Protocol
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Understanding the liquidation process through practical examples in the Fixed-Rate Lending Protocol
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There are two main patterns that trigger liquidation in the Fixed-Rate Lending Protocol. One is when your collateral value decreases against your borrowed asset, typically represented by currency exchange rate fluctuations. The other is when the borrowed asset value increases compared to your collateral, which might occur when borrowing rates go lower. This case study explores these scenarios through practical examples.
Let's examine a practical example of how liquidation works in the Fixed-Rate Lending Protocol:
Bob borrowed 1,000 FIL with 15,000 USDC for 1y (365 days) at 20% at FILUSDC 10.0. Hence Bob's borrowed value is 10,000 USDC (= 1,000 FIL * 10.0 FILUSDC FX rate), and his LTV is 66.7% (10,000/15,000).
IF the FILUSDC exchange rate spike to 12.0 from 10.0 right after he borrowed, the value of his collateral decreases against his liability. In other words, his liability increased to 12,000 USDC (=1,000 FIL * 12.0 FILUSDC FX rate). As a result, 50% of his position will be subject to liquidation since LTV reached 80% (12,000/15,000).
Our Smart-contract will repay half of his obligation, helped by the liquidator, which is 500 FIL. Instead, Bob will lose his collateral of 6,420 USDC (=500 FIL * 12.0 FILUSDC FX rate * 107% penalty).
After the liquidation process, Bob's position will be 500 FIL cash, 500 FIL borrowed with 8,580 USDC collateral (15,000 - 6,420 USDC). His LTV recovered to 69.9% (=500 FIL * 12.0 FILUSDC FX rate / 8,580 collateral).
Liquidation Threshold
LTV ratio at which a position becomes eligible for liquidation
80%
Liquidation Penalty
Additional fee applied to liquidated collateral
7%
Liquidation Amount
Portion of the position that gets liquidated when threshold is reached
50%
Post-Liquidation Target
Target LTV ratio after liquidation
~70%
Exchange Rate Impact
How exchange rate changes affect LTV calculations
Direct impact on borrowed value
Initial Position:
Alice deposits 10 ETH (worth $20,000) as collateral
Alice borrows 12,000 USDC
Initial LTV: 60% ($12,000 / $20,000)
Liquidation threshold: 80%
Market Change:
ETH price drops from $2,000 to $1,600 per ETH
Collateral value decreases to $16,000 (10 ETH × $1,600)
New LTV: 75% ($12,000 / $16,000)
Further Market Change:
ETH price drops further to $1,500 per ETH
Collateral value decreases to $15,000 (10 ETH × $1,500)
New LTV: 80% ($12,000 / $15,000)
Position becomes eligible for liquidation
Liquidation Process:
50% of the position is liquidated (6,000 USDC debt)
Liquidator repays 6,000 USDC
Alice loses 4.28 ETH as collateral (6,000 USDC × 1.07 penalty / $1,500 per ETH)
Remaining position: 5.72 ETH collateral and 6,000 USDC debt
Post-liquidation LTV: ~70% ($6,000 / ($1,500 × 5.72))
Initial Position:
Charlie deposits 100,000 USDC as collateral
Charlie borrows 10 BTC (worth $600,000 at $60,000 per BTC)
Initial LTV: 60% ($600,000 / $1,000,000)
Market Change:
BTC price increases to $75,000 per BTC
Borrowed value increases to $750,000 (10 BTC × $75,000)
New LTV: 75% ($750,000 / $1,000,000)
Further Market Change:
BTC price increases to $80,000 per BTC
Borrowed value increases to $800,000 (10 BTC × $80,000)
New LTV: 80% ($800,000 / $1,000,000)
Position becomes eligible for liquidation
Liquidation Process:
50% of the position is liquidated (5 BTC debt)
Liquidator repays 5 BTC (worth $400,000)
Charlie loses 42,800 USDC as collateral ($400,000 × 1.07 penalty)
Remaining position: 57,200 USDC collateral and 5 BTC debt
Post-liquidation LTV: ~70% ($400,000 / $57,200)
Liquidations are triggered when a borrower's Loan-to-Value (LTV) ratio reaches or exceeds 80%. This can happen in two main ways:
When the value of the collateral decreases relative to the borrowed asset (e.g., collateral price drops)
When the value of the borrowed asset increases relative to the collateral (e.g., borrowed asset price rises)
When your position reaches the liquidation threshold, 50% of your borrowed amount will be liquidated. This partial liquidation approach helps to bring your position back to a safer LTV ratio (typically around 70%) while minimizing the amount of collateral you lose.
The liquidation penalty is currently set at 7% of the liquidated debt value. This penalty serves several purposes:
It incentivizes liquidators to participate in the liquidation process
It discourages borrowers from taking excessive risk
It provides a buffer for the protocol against potential losses during volatile market conditions
Yes, you can prevent liquidation by:
Adding more collateral to decrease your LTV ratio
Repaying part of your debt to decrease your LTV ratio
Monitoring market conditions and taking proactive action before reaching the liquidation threshold
After liquidation, you will have:
50% of your original borrowed amount remaining as debt
Your original collateral minus the amount taken during liquidation (including the 7% penalty)
A healthier LTV ratio (typically around 70%)
The ability to continue using the protocol with your remaining position