Liquidation
Borrowers who consume over 100% of their borrow limit are eligible for liquidation.
How liquidations work
Liquidators repay a portion of a borrower's loan in exchange for an equal portion of their collateral plus some incentive.
For example, if a borrower uses ETH as collateral and ETH is priced at $2000 and a liquidator repays $1000 of the borrower's debt, they receive 0.5 ETH ($1000) + 10% liquidation incentive from the borrower's collateral. In this case, the liquidator's total reward would be 0.55 ETH ($1100). In this case, the borrower paid a penalty of $100 (0.05 ETH).
Liquidation rules
Liquidators are required to follow 3 rules when liquidating any borrower. Consider a liquidatable position that is backed by different collateral tokens and borrows different tokens.
Liquidators may only repay the most borrowed token in the position in dollar terms
Liquidators may only receive the most deposited collateral in the position in dollar terms
Liquidators may receive a maximum of $1000 in additional liquidation incentive per liquidation
Based on rule 1 and 2, a borrower can predict which collaterals or loans will be impacted in case of a future liquidation. For example, if a borrower wishes to protect a specific collateral token from being rewarded to liquidators, they can ensure that said collateral is not the most valuable in dollar terms relative to other collaterals in their position.
Based on rule 3, positions of smaller size may be fully liquidated in fewer liquidation transactions than larger positions. This minimizes losses due to liquidations for large positions as well reduces the systemic risk of liquidation cascades.
Avoiding liquidation
In order to avoid liquidation, borrowers are advised to constantly monitor their borrow limit usage. If your usage is nearing 100%, either reduce your limit usage by repaying some loans or increase your limit by adding more collateral.
Another strategy is reduce liquidation risk is to diversify your collateral exposure among multiple non-correlated assets in order to prevent full exposure to the price of a single collateral.
Last updated