Liquidations

Introduction

A liquidation is a process that occurs when a borrower's health factor goes below 1 due to their collateral value not properly covering their loan/debt value. This might happen when the collateral decreases in value or the borrowed debt increases in value against each other. This collateral vs loan value ratio is shown in the health factor. In a liquidation, up to 50% of a borrower's debt is repaid and that value + liquidation fee is taken from the collateral available, so after a liquidation that amount liquidated from your debt is repaid.

How much is the liquidation penalty?

The liquidation penalty (or bonus for liquidators) depends on the asset used as collateral. You can find every assets' liquidation fee in the risk parameters section.

Can you give me an example?

Sure! A couple of them here:

Example 1

Clara deposits 15 LINK and borrows 7 USDC worth of USDC (yes, she borrows USDC to hold USDC).

If Clara's Health Factor drops below 1, her loan will be eligible for liquidation. A liquidator can repay up to 50% of the borrowed amount, which is 3.5 USDC. In return, the liquidator can claim 15 LINK (the collateral) with an additional bonus of 0.75 LINK (5% of the collateral value).

This means the liquidator would get a total benefit of 3.5 USDC (debt repaid) + 0.75 LINK (bonus) for taking on the liquidated debt.

Example 2

David deposits 5 ETH and 4 ETH worth of UNI tokens, and borrows 5 ETH worth of DAI.

If David's Health Factor drops below 1, his loan will be eligible for liquidation. A liquidator can repay up to 50% of the borrowed amount, which is 2.5 ETH worth of DAI. Since the liquidation bonus is higher for UNI (15%) compared to ETH (5%), the liquidator chooses to claim UNI tokens as collateral.

Therefore, the liquidator would receive 2.5 ETH worth of UNI tokens (collateral) along with an additional bonus of 0.375 ETH worth of UNI tokens (15% of the collateral value). This translates to a total benefit of 2.5 ETH worth of DAI (debt repaid) + 0.375 ETH worth of UNI (bonus) for taking on the liquidated debt.

How can I avoid getting liquidated?

To avoid liquidation you can raise your health factor by depositing more collateral assets or repaying part of your loan. By default, repayments increase your health factor more than deposits. Also, it's important to monitor your health factor and keep it high to avoid a liquidation. Keeping your health factor over 2, for example, gives you more of a margin to avoid a liquidation.

You should be mindful of the stablecoin price fluctuations due to market conditions and how it might affect your health factor. For example, the market price of USDC 1.00 might not equal exactly USD 1.00, but for example USD 0.95. The price fluctuations of stablecoins, like any assets, affects your health factor. You can find more details of price oracles in the price discovery section.

Can I participate in the liquidations ecosystem?

Yes, liquidations are open to anyone, but there is a lot of competition. Normally liquidators develop their own solutions and bots to be the first ones liquidating loans to get the liquidation bonus.