A liquidation is a process that occurs when a borrower's account liquidity drops below zero as their loan values exceed their collaterals' borrow values. This situation occurs when the collateral decreases in value or the borrowed debt increases in value against each other. When a borrower's account liquidity drops below zero, their borrow capacity will exceed 100% and they can no longer borrow or withdraw.
In a liquidation, up to 50% of a borrower's debt is repaid. This cap can be adjusted by governance and will likely decrease as the platform matures.
Accounts that are liquidated will be charged a liquidation fee paid to the liquidator. The fee is set as a % of debt liquidated. The net amount of collateral left in a borrower's account after liquidation is the paid back value + the liquidation fee.
What is the Liquidation Fee?
In order to pay back delinquent borrows, liquidators have to take execution risk between the collateral they are liquidating and the borrow they have paid back on behalf of the borrower. The liquidation fee compensates liquidators for this risk.
The liquidation fee is set at 10% across all assets.
Bob deposits 10 ETH at and borrows 5 ETH worth of USDC.
If ETH is currently at $1,000/ETH, that means Bob's Non-Boosted Borrower power = 10 * $1,000 * 75% = $7,500. Bob's USDC borrow is worth $5,000.
Bob's account has liquidity of $7,500 - $5,000 = $2,500
ETH gaps down by 50% to $500. Bob's 10 ETH is now worth = 10 * $500 * 75% = $3,750.
Bob's account liquidity is $3,750 - $5,000 = -$1,250
The liquidator can repay up to 50% of the borrow USDC or $2,500. In addition, a liquidator gets 10% fee of the liquidated amount or another $2,500 * 10% = $250.
Thus, the liquidator can take the repay amount + fee = ($2,500 + $250) / (current price of ETH = $500) = 5.5 ETH.
How to avoid liquidation?
Keep your borrow capacity used under 75%.
In times of volatility, decrease borrow capacity used to under 50%.