Undercollateralized loans are based on trust. Lenders do a credit check and hope the loan gets paid back. Whenever that trust gets violated, this has consequences as seen in Q2 2022. For this reason overcollateralized protocols, like AAVE, although inefficient, focus on providing trustless loans. They are able to do this by liquidating loans as they near insolvency.
With DeltaPrime we are evolving the current lending system, combining the best of both worlds: the capital efficiency of protocols like Goldfinch with the trustlessness of protocols like AAVE. Liquidations are one of the main security measures of DeltaPrime. It ensures that loans can be safely repaid. If the collateral ratio of a prime brokerage account hits or drops below 20%, part of the borrowed funds get liquidated. Part of the outstanding borrows will be repaid in order to increase the collateral ratio back to a healthy percentage.
As a security measure everyone is able to run liquidation bots on DeltaPrime. If a Prime Account's collateral ratio hits or drops below 20%, all liquidation bots are incentivised to perform a liquidation on that account. Instead of liquidating the account fully, liquidation bots can liquidate only part of the account, up to a collateral ratio of 25%. This way borrower's don't lose everything due to a price spike, while depositors stay protected. Whenever a liquidation bot successfully liquidates a position, they will get a liquidation bonus as an incentive, paid by the Prime Account.
In the extreme case that the loan is so small that the liquidation bots don't have enough incentive to liquidate, protocol-owned liquidation bots will liquidate the position. This might mean the liquidation happens at a small loss for the protocol, which will be covered by insurance funds in the treasury. The treasury will be filled with a part of the protocol revenue. This method secures the funds of depositors as to prevent them from losing their capital due to a large amount of illiquid ghost contracts or black swan events.
Liquidation bots are an essential part of DeltaPrime's security. For this reason we incentivise users to run their own bots on the platform. Read here how to create and run your own DeltaPrime liquidation bot.
Borrowed funds have to be repaid in the same currency as they were issued with. When liquidation occurs the bot will pay back the loan in following steps:
- 1.Calculate how much should be repaid to bring the loan back to a safe level.
- 2.Repay part of the loan from tokens supplied by liquidation bot.
- 3.Transfer part of account positions + liquidation bonus to the liquidator (of the same USD value as supplied in pt. 2).
This is a highly summarised version. For the full liquidation process, including a liquidation example, see this document:
DeltaPrime liquidation process (1).pdf