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Liquidation

Understanding Liquidation Event

To maintain the OINDAO system's solvency, a Liquidation Event is immediately triggered when a user's C-Ratio has fallen below OINDAO's Minimum Collateralization Ratio (MCR) required for the associated collateral. During a Liquidation Event, the liquidated person will lose a proportion of the their collateral that is equivalent to 110% of the borrowed loans (taking into account the value of the Liquidation Reserve) to compensate the Liquidators and the Stability Providers. However, the user will still be able to keep the full amount of the stablecoin borrowed, excluding the Liquidation Reserve. Once the liquidation process is completed, the liquidated person will be able to withdraw the remaining collateral.
To illustrate the above using an example, Alice happens to have borrowed 1,000 aUSD against $2,000 worth of AVAX, this includes the 20 aUSD that has been set aside as Liquidation Reserve. If the total value of her AVAX collateral drops, resulting in the C-Ratio for Alice's aUSD loans to fall below the system's required MCR e.g., 180%, a Liquidation Event will be triggered. She will lose $1,100 worth of AVAX (price taken at the time of liquidation), and 20 aUSD for which she deposited to open the Vault. Alice can hold on to the remaining 1,000 aUSD - 20 aUSD Liquidation Reserve = 980 aUSDloans, and she will be able to retrieve the remaining AVAX collateral when the liquidation process has been completed. The remaining value in Alice's Vault will be: $2000 worth of AVAX - $1,100 worth of AVAX + 980 aUSD = $1,880, incurring a loss of $2,000 - $1,880 = $120.

Introducing Liquidators

Liquidators are initiators of Liquidation Events. Anybody can become a Liquidator and initiate liquidation as soon as they see a Vault's C-Ratio falls below 180%. To compensate for the Liquidators' effort, they will receive the $20 stablecoin Liquidation Reserve and 0.5% of the liquidated collateral as rewards.
In order to maintain the system's robustness, OINDAO adopts a two-step liquidation mechanism:

Step-1: Stability Pool - the frontline keeper of the OINDAO protocol

What is the Stability Pool?

The Stability Pool is a liquidity reserve funded by users' staked stablecoins, these users are also known as Stability Providers. The Stability Pool acts as the first line of defence in maintaining the system's solvency.
During a Liquidation Event where a Vault is being liquidated, the outstanding debt will first be repaid using funds in the Stability Pool. At the same time, the collateral in the liquidated Vault will be transferred to the Stability Pool and proportionately distributed to Stability Providers of the Stability Pool.

Who are the Stability Providers?

When users mint stablecoins using OINDAO, they can choose to become Stability Providers by providing stablecoins to the Stability Pool to support potential liquidation. To compensate for their risks, 99.5% of liquidated collateral is transferred to the Stability Pool, while the remaining 0.5% will be allocated to Liquidators as compensation for their liquidation effort. As a result of this process, Stability Providers will lose their proportionate share of the stablecoins, but gain on their proportionate share of liquidated collateral. Stability Providers are able to claim their rewards and withdraw their deposits at any time.
To illustrate the process above using an example, Alice has staked 10,000 aUSD in a Stability Pool that contains $1,000,000 worth of stablecoins, resulting in a 1% share for Alice in the Stability Pool. Suppose the current price of AVAX is $50, and there is a Vault with 28,000 aUSD loans (including Liquidation Reserve) and 1,000 AVAX. Because the resulting C-Ratio for the Vault is 179% - lower than the required Minimum Collateralization Ratio set at 180%, the Vault will be liquidated. The resulting liquidation requirement will be 28,000 aUSD * 110% = 30,800 aUSD worth of AVAX, translating to $30,800 / $50 = 616 AVAX, assuming a 1:1 stablecoin price peg (see details on The USD Soft Peg) . 99.5% of the collateral 616 AVAX * 99.5% = 613 AVAX will be transferred to the Stability Pool, the remaining collateral and the 20 aUSD Liquidation Reserve will be allocated to the Liquidator.
Given Alice's share of the Stability Pool is 1%, she will carry 1% of the undercollateralized debt burden 1% * 28,000 aUSD = 280 aUSD. As compensation, she will also be allocated 1% of the liquidated collateral that's allocated to the Stability Pool 1% * 613 AVAX = 6.13 AVAX, resulting in a net gain of $50 * 6.13 AVAX - 280 aUSD = $26 for Alice.

What are the risks of becoming a Stability Provider?

Because the system's Minimum Collateralization Ratio will be set at 180%at default, and will always be kept above 100%, it is highly likely that Stability Providers will generate a positive yield.
However, Stability Providers may risk losing money in the unlikely event of a flash crash, during which C-Ratio of the collateral reaches below 100% too fast due to a sharp price drop in the underlying collateral. In addition, Stability Providers may incur an impermanent loss during liquidation if the price of the stablecoin is trading above $1. However, as prices of OINDAO's stablecoins will always aim to return to the 1:1 peg, losses will only become permanent if the Stability Provider decides to withdraw and sell the stablecoin deposit before it returns to the peg.

Step-2: Redistribution mechanism - the second line of defence

Should the stablecoin reserve in the Stability Pool become exhausted, the OINDAO system will redistribute the undercollateralized debt and the associated collateral to all other existing Vaults. The redistribution amount will be made in proportion to each user's stake in the overall collateral pool. Just like the Stability Pool mechanism, while it is highly likely that users who have been distributed additional debt and collateral to make profit as the MCR will always be above 100%, it may lower the user's overall C-Ratio. The user may choose to top-up with additional collateral or repay some debt to lower the C-Ratio, and in turn helps to strengthen the system's stability.
Last modified 2mo ago