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Safeguarding the stability of the system by managing undercollateralized positions
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.
- 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.
When a position is considered unviable, they are open to being liquidated.
Traditionally, liquidations are done by people who write bots, enjoying a monopoly on liquidation fees. On Carbon, in the spirit of decentralization, anyone can participate in liquidations (i.e. bid for liquidations) on the money market. This is done by allowing any user (the ”liquidator”) to repay the position’s debt by transferring the required assets.
The article below explain how liquidations are triggered and executed on Carbon:
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.
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.
How much is the Liquidation Bonus (or Penalty)?
Each asset has its own liquidation bonus, and assets that are more volatile require higher liquidation discounts, as liquidators suffer more slippage when converting out of the collateral asset.
Liquidation Bonus is a variable parameter that can be adjusted via Carbon Governance.
Example The Liquidation Bonus for ATOM is set at 5%. Out of this 5%,
- 10% is charged as Liquidation Fee and goes to stakers
- Remaining 90% goes to Liquidators
E.g. Fees & Liquidation Information for ATOM on Carbonscan
To view the Fees & Liquidation Info for a specific asset on Carbonscan,
- 1.Click on 'Borrowable Assets' under the 'Assets' toggle.
- 2.Click on a specific asset e.g. ATOM and you will be directed to 'The Borrowable Asset Details' page for the asset.