How does Liquidations work?

When borrowing assets on Native, borrowers face the risk of liquidation if the value of their collateral falls below the required over-collateralization level. This can happen if the price of the borrowed asset moves against the borrower, triggering a liquidation event. At this point, the borrower must either deposit additional collateral or face liquidation to repay the lender.

Triggering liquidations

Liquidations occur when a user’s Loan to Value (LTV) ratio exceeds the Liquidation Threshold. This can happen due to:

• Depreciation of the collateral asset compared to the borrowed asset.

• Appreciation of the borrowed asset relative to the collateral.

• Accrual of borrow interest to the point where the amount owed exceeds the liquidation threshold.

Liquidation

Liquidation penalty and incentives

A fee is imposed during liquidation, which serves as an incentive for liquidators to act swiftly and help maintain Native's stability.

The liquidation penalty paid by borrowers equals the liquidation incentive received by liquidators, before accounting for liquidation fees.

Liquidation penalty for borrowers

The Liquidation Penalty is a fee paid by borrowers to liquidators when a liquidation occurs. During liquidation, a portion of the collateral assets is used to pay off the outstanding loan plus the Liquidation Penalty.

Borrowers should strive to keep their positions adequately over-collateralized to avoid incurring this penalty.

On Native, the liquidation penalty is set at 8%.

Example If a debt of 1,000 USDC is liquidated, the borrower can expect 1,080 USDC worth of their collateral to be liquidated.

Liquidation incentive for liquidators

By repaying a borrower's debt, a liquidator can seize the collateral associated with that debt at an incentive. This encourages liquidators to compete for these "free" profits, helping Native quickly resolve unviable positions before they become deficits.

On Native, the liquidation incentive is set at 8% for most assets, with higher incentives for more volatile assets to compensate liquidators for potential slippage when converting the collateral.

Liquidation fees

Additionally, a 2.5% to 3% liquidation fee is imposed on the Liquidation Incentive for all assets, which accrues to the protocol.

Example If the liquidation incentive for USDC is set at 8%, out of this 8%, 3% is charged as a liquidation fee and goes to the protocol, while the remaining 97% goes to liquidators. If a debt of 1,000 USDC is liquidated, the liquidator can expect to receive 1,080 USDC worth of collateral. After accounting for the 3% liquidation fee, the liquidator profits with 1,047.60 USDC worth of collateral.

Calculating max liquidation and repayment amount

To determine the maximum amount that can be liquidated, the borrower's debt is multiplied by the Close Factor; This gives the maximum amount of collateral that can be liquidated.

Here is an example:

Parameters

• Loan to Value (LTV): 85% or 0.85

• Liquidation Threshold: 88% or 0.88

• Liquidation Incentive: 8% or 0.08

• Liquidation Fee: 3% or 0.03 (goes to protocol)

• Minimum Close Factor: 0.10

• Close Factor: Variable, determines the percentage of the borrower's collateral that can be liquidated.

Scenario

A borrower provides $100,000 in USDC as collateral and borrows $85,000 in STONE, which is the maximum LTV.

Initial Position

• Collateral: $100,000 in USDC

• Borrowings: $85,000 in STONE

• Loan to Value (LTV): 85% (below Liquidation Threshold)

• Health Factor: $\text{Health Factor} = \frac{\text{Collateral Value} \times \text{Liquidation Threshold}}{\text{Borrow Value}} = \frac{100,000 \times 0.88}{85,000} = 1.03529 \, (> 1)$

Position After Market Changes

The value of the borrowed STONE increases to $92,500, bringing the user’s LTV ratio to 95.2%, exceeding the Liquidation Threshold of 88%.

• Collateral: $100,000 in USDC

• Borrowings: $92,500 in STONE

• Loan to Value (LTV): 92.5% (above Liquidation Threshold)

• Health Factor: $\text{Health Factor} = \frac{\text{Collateral Value} \times \text{Liquidation Threshold}}{\text{Borrow Value}} = \frac{100,000 \times 0.88}{92,500} = 0.95135 \, (< 1)$

The borrower will be liquidated to ensure their position remains over-collateralized.

Liquidation Calculation

1. Calculate Critical Borrowed Value (B)

$B = \text{Liquidation Threshold} + (\text{Collateral Value} - \text{Liquidation Threshold}) \times \text{Critical Liquidation Threshold (CLT)}$

Example: Given that CLT is set to 0.7, we calculate:

$B = 88,000 + (100,000 - 88,000) \times 0.7 = 88,000 + 12,000 \times 0.7 = 96,400$

Close Factor = 1 when Borrowed Value hits the critical amount of $96,400.

1. Calculate Close Factor (CF)

$\text{Close Factor (CF)} = \frac{\text{Debt} - \text{Liquidation Threshold}}{\text{Collateral Value} - \text{Liquidation Threshold}} \times (1 - \text{Minimum CF}) + \text{Minimum CF}$

$CF = \frac{92,500 - 88,000}{100,000 - 88,000} \times (1 - 0.1) + 0.1 = \frac{4,500}{12,000} \times 0.9 + 0.1 = 0.3375 + 0.1 = 0.4375$

1. Calculate maximum amount that can be liquidated

$\text{Max Liquidation Amount} = \text{Close Factor} \times \text{Debt} = 0.4375 \times 92,500 = 40,468.75$

The liquidator can liquidate up to $40,468.75 worth of the debt. After repaying the debt, the liquidator receives the collateral with an incentive:

$\text{Collateral Received} = 40,468.75 \times 1.08 = 43,705.25$

Out of this, 3% goes to the protocol as a fee, and the rest goes to the liquidator.

$\text{Liquidator's Profit} = 43,705.25 \times 0.97 = 42394.09$

Avoiding liquidations

As Native allows multiple types of assets to be used in a single Collateralized Debt Position (CDP), calculating the exact liquidation point can be complex due to varying Loan-to-Value (LTV) ratio for different collaterals.

To safeguard collateral and mitigate liquidation risks, it is essential to monitor your account's Health Factor. Borrowers can improve their Health Factor by depositing more collateral or repaying part of their loan. Generally, repayments have a more significant positive impact on the Health Factor compared to deposits.