Liquidations
A borrower’s loan must always be sufficiently capitalized above a Liquidation Threshold. i.e. Collateral Value * LVR. Loans that fall below the Liquidation Threshold may be subject to liquidation by Liquidators who repay the loan and in return receive a greater portion of the position’s collateral.
A loan’s Health Factor is a measure of its relation to the Liquidation Threshold. A Health Factor greater than one (1) indicates the loan is suitably capitalized above the Liquidation Threshold. A Health Factor less than one (1) indicates the loan is not suitably capitalized and is below the Liquidation Threshold.
A liquidation event incurs a Liquidator Fee. The Liquidator Fee varies depending on the loan’s Health Factor. The lower the loan’s Health Factor, the greater the reward that will be awarded to the liquidator.
Fringe employs partial liquidations. This provides a number of benefits, as follows:
- Minimizes the impact to borrowers during liquidation events.
- The way this minimizes impact to borrowers is by borrowers being charged only the liquidator reward fees associated with the partial liquidation to bring the loan back above the minimum collateralisation level.
- Additionally, the borrower retains the remaining open loan position they entered into and thus is still positioned according to their original intent (i.e. exposed to the upside potential of their collateral asset.)
- Partial liquidations also provide a benefit to the Fringe platform.
- Partial liquidations invite more liquidators to participate given lower secondary market liquidity requirements to dispose of collateral won in a liquidation. This makes Fringe’s liquidation process more efficient and aims to reduce the likelihood of positions becoming insolvent.
This improves the Fringe platform’s stability. The mechanisms for partial liquidations are as follows:
- 1.Allow liquidators to choose the amount they wish to liquidate up to a MaxLA - Max Liquidation Amount).
- MaxLA is the amount the position needs to be liquidated that will result in the loan position attaining the Target Health Factor
- MaxLA is calculated as described below in the heading MaxLA - MAX_LIQUIDATION_AMOUNT Calculation.
- 2.Establishes a mechanism similar to an auction which increasingly incentivizes liquidators as the loan position’s Health Factor falls. The LRF - Liquidator Reward Factor is a function of the Health Factor, where a lower HF results in a higher LRF (not necessarily proportionally).
- Once a partial liquidation occurs, the auction continues. LRF is still calculated as a function of the prevailing Health Factor.
- To note, Fringe Lending's existing full-position liquidation model provides a liquidator reward of 7%. This is currently a parameter on a per-collateral-asset basis.
- To note: With this new liquidation model, there is no explicit auction process (like, say, DAI’s liquidation model.) Liquidators simply participate based on the prevailing LRF which is a function of the prevailing Health Factor.
- Given there is no explicit auction process, there is no additional actor who needs to initiate an auction. i.e. there is no “two-step process” for liquidations. This is mentioned here just to distinguish Fringe’s model from the DAI model which requires an actor to initiate a liquidation auction.
- Any liquidator can liquidate up to the MaxLA.
- The borrower will still have an open loan position after the partial liquidation.
- If the liquidator liquidates an amount equal to MaxLA, the position will be returned to HF> 1. i.e. healthy, unliquidatable. (And if the liquidator liquidates an amount less than MaxLA, HF may be less than 1 and there remains an opportunity for another liquidator to perform a liquidation for another amount up to the newly-calculated MaxLA.)
- Fringe’s previous full liquidation model will be retired.
- Once this new partial liquidations model is implemented, it will not be possible for liquidators to expressly perform full liquidations via that retired facility.
- However, it may be the case that a ‘full liquidation’ can occur via this new partial liquidation model.
- The way this can occur is when MaxLA >= Outstanding loan value. I.e, if the new partial liquidation model results in a 'full liquidation' scenario, then this is permitted (via the new 'partial' liquidation model.)
- I.e. Liq amount can be any value between and including MinLA & MaxLA, and if MaxLA > Outstanding Loan Value, then MaxLA = Loan value.
(*) In the future, Fringe may implement a different curve and other rules that attempt to address issues such as further minimizing risk of price manipulation attacks and front-running. For the time being, Fringe has implemented this formula above but has constructed the partial liq mechanism to allow a new model to be applied as and when needed.
- MaxLA - MAX_LIQUIDATION_AMOUNT Calculation MaxLA = (LVR * CVc - THF * LVc) / (LRF * LVR - THF) Where:
- MaxLA = dollar amount needed to reduce the loan to bring the loan to the Target Health Factor.
- LVc = current loan value.
- CVc = current collateral value.
- LVR = loan to value ratio for the loan’s collateral type.
- LRF = liquidator reward factor factor. e.g. 107%, but this is calculated based on the current Health Factor.
- THF = Target Health Factor. e.g. 110% The aim of THF is to bring the loan position to a healthy state. E.g. to Health Factor = 1.1.
- If MaxLA > Outstanding Current Loan Value (LVc), then set MaxLA = LVc.
- The reason for this rule is to allow a loan position to be effectively fully liquidated with this ‘partial liquidation’ facility when required to maintain the platform’s stability. i.e. when MaxLA > LVc.
- If Collateral paid to the liquidator > CVc, then set Collateral paid to the liquidator = CVc. (This allows Fringe DAO to liquidate any insolvent positions at a loss if the need ever arises.)
- MinLA - MIN_LIQUIDATION_AMOUNT Calculation.
- Fringe will specify a system-wide dollar amount called MPA - MIN_PARTIAL_LIQUIDATION_AMOUNT. The following formula is to be used to derive MinLA - MIN_LIQUIDATION_AMOUNT MinLA = min(MaxLA, MPA)
- To note: MPA is a stored parameter whereas MinLA is calculated.