๐Ÿ“‰Liquidation Mechanism


A borrower on Ion becomes liquidateable when the value of their liabilities supersedes the value of the collateral that their position is mapped to on the consensus layer (i.e. the Health Factor (HF), the ratio of the value of debt to the value of the collateral, becomes less than 1).

1>collateralValuedebtValue=HF1 > \frac{collateralValue}{debtValue} = HF

Liquidations occur in a manner mostly traditional to the status quo, where the liability is shored up by an external party and the collateral is then purchased at a discount by said party. To find out more about them go to the Keepers page in the documentation.

Proof-of-Reserve Backed Liquidations

All liquidations within Ion occur completely independent to the secondary market price of the collateral that is deposited. Liquidations on Ion are instead initiated by changes in the underlying balances of the validators within the beacon chain. If the quantity of the underlying collateral that supports a collateral asset in the beacon chain decreases such that positions exceed their liquidation threshold, those positions will be liquidated. See ZK-Enabled Proof-of-Reserve for more information about this mechanism.

It's important to note that liquidators may continue to operate on market price since they are looking for atomic profit. A position can be liquidatable on Ion (because of a sufficiently large slashing event), but the liquidation is unprofitable because the market price has fallen even further. This is something expected and something that is OK. This liquidation module serves as a nice-to-have where if liquidations are possible on market price, Ion will allow them.

But the true solvency maintenance can happen deterministically. Ion protocol, given data from the beacon chain can seize unhealthy vaults, redeem the collateral into the beacon chain, and repay the unbacked debt itself. This is possible because Ion operates on the assumption that liquidations are not time-sensitive the way they would be with price-based liquidations.

Once one slashing event has happened, it is unlikely that another will take place within a short time (other than the correlated slashing penalty 18 days later).

Partial Liquidations

Unlike many lending protocols that exercise a fixed discount rate for liquidators to shore up debt in a marketplace, Ion leverages a scaling discount rate and partial liquidation mechanism that allows the reward of a liquidation to scale in accordance to the decreasing health of a position and creates a softer upper bound to the extent in which a position's collateral can be bought. This upper bound is meant to allow liquidators to pay back only the amount necessary to bring a liquidate-able position to safety without incurring additional losses for the borrower (i.e. as debt is paid back, the health factor increases). This safe level is indicated by:

HFโ‰ฅ1.10HF \geq 1.10

Discount - The benefit to the liquidator.

This represents price discrimination - in a way, it represents a pseudo dutch auction. As the health factor of the CDP decreases the discount increases.

1.10โˆ’11โˆ’maxDiscount=01.10 - \frac{1}{1-maxDiscount} = 0

Max discount is reached at 0.091 which would mean that a position reached a 0.91 health factor.

maxDiscount=0.091maxDiscount = 0.091

Liquidation Scenarios

  1. The vault is not in a liquidatable state (healthy vault). This would lead to the liquidation failing

Then, 3 different types of liquidations depending on how unhealthy the vault is (This will be a high-level summary. See Deriving the Three Potential Cases for a more detailed derivation of the math)

  1. Partial Liquidation - There is enough collateral within the vault when sold at the current discount rate to reach the target health ratio.

  2. Dust Liquidation - While there is enough collateral within the vault when sold at the current discount rate to reach the target health ratio, the amount of debt being paid off would result in the total debt being below the dust or the smallest amount possible in a position. In this case, force a liquidation of the full position.

  3. Protocol Liquidation - There is not enough collateral within the vault when sold at the current discount rate to reach the target health ratio. Assuming MEV searchers only execute profitable transactions, it's never expected for this scenario to be executed.

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