Liquidation Mechanism

How it works

When users opt to utilize one of their positions as collateral and borrow liquidity, they bear the risk of potential liquidation. Liquidation mechanisms are designed to protect the protocol and its liquidity providers by closing out under-collateralized positions before the loan becomes underwater. This ensures there are sufficient funds remaining in the lending pool for LP to withdraw their balances.

Liquidation Thresholds

Liquidation thresholds govern the liquidation and borrow mechanism based on Loan-to-Value and Health Factor.

The Loan-to-Value (LTV) ratio determines the maximum amount of loan a borrower can receive when using their options as collateral. The LTV ratio is not dynamic and is set by the protocol.

$$\boldsymbol{LTV=\frac{Borrowed\ Assets}{Collateral}}$$

As long as LTV is < 75% (Maximum LTV), users can borrow assets.

The Health Factor represents the ratio of the value of a user’s locked collateral to the value of their outstanding loan. The Health Factor changes dynamically as the value of the user’s collateral fluctuates. When collateral value increases, the Health Factor rises and when the collateral value decreases, the Health Factor falls.

$$\boldsymbol{HF(t)=\frac{Collateral (t)\ *\ Liquidation \ Threshold}{Borrowed\ Assets}}$$

The Liquidation Threshold is initially set at Maximum LTV + 10%.

The Health Factor determines whether a user's position is considered over-collateralized or under-collateralized.

When the Health Factor cross 1, the position is considered under-collateralized and at risk of liquidation.

Manage and avoid Liquidation

Users can monitor their Health Factor and take action to avoid liquidation, such as adding more collateral or paying back part of their loan. Maintaining a sufficiently high Health Factor is crucial for borrowers to avoid losing their collateral and incur a penalty.