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 110.5% (the Liquidation Cost) of the borrowed loans (taking into account the value of the Deposit) 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 Deposit. 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 10 aUSD that has been set aside as Deposit. 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., 160%, a Liquidation Event will be triggered. She will lose $1,105 worth of AVAX (price taken at the time of liquidation), and 10 aUSD for which she deposited to open the Vault. Alice can hold on to the remaining 1,000 aUSD - 10 aUSD Liquidation Reserve = 990 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 - $1,105 worth of AVAX + 990 aUSD = $1,885, incurring a loss of $2,000 - $1,885 = $115.
In the unlikely event that there is a sharp drop of the collateral token price that results in the C-Ratio falling below 110.5%, all of the remaining collateral will be collected as Liquidation Cost.
Introducing Liquidators
Liquidators are initiators of Liquidation Events. While it's usually triggered by bots, the OINDAO V3 is designed in a way that anybody can become a Liquidator and initiate liquidation as soon as they see a Vault's C-Ratio falls below the MCR. To compensate for the Liquidators' effort, they will receive the $10 stablecoin Deposit 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 V3 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 V3, they can choose to become Stability Providers by providing stablecoins to the Stability Pool to support potential liquidation.
If a Liquidation Event is triggered, the undercollateralized debt position will be repaid using the stablecoins provided by the Stability Providers. The amount taken from each Stability Provider is proportion to their stake in the Stability Pool. As a result of this, Stability Providers will see that their stablecoin deposit in the Stability Pool will reduce.
To compensate the Stability Providers for the risks they are taking, as well as the for the funds they are providing for debt settlement, a large proportion of the liquidated collateral taken as the Liquidation Cost will be allocated to the Stability Providers proportionate to their stake in the Stability Pool. Because the Liquidation Cost is set at 110.5%, this means that Stability Providers' stability provision compensation value is most likely higher than the value of the debt they helped settle, yielding each of them a net profit.
There will be 2 scenarios with different liquidated collateral distribution schedules for the collected 110.5% Liquidation Cost:
Scenario 1: The liquidated user's C-Ratio is above 108.5% at the time of liquidation:
The Liquidation Cost will be distributed according to the following schedule:
0.5% will be allocated to the Liquidator
108% will be allocated to the Stability Providers
The remainder will be sent to the Treasury
Scenario 2: The liquidated user's C-Ratio is below 108.5% at the time of liquidation
This scenario takes place in the unlikely event that there is sudden steep drop in the collateral token price. As a result, the Liquidation Cost will be distributed according to the following schedule:
0.5% will be allocated to the Liquidator
The remainder will be allocated to the Stability Providers
No collateral will be sent to the Treasury
What are the risks of becoming a Stability Provider?
Because the system's Minimum Collateralization Ratio will be set at 160%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.
What is the purpose of the Treasury?
The Treasury serves as a fund reserve for the OINDAO to deploy at times of emergency, e.g., a black swan event in the market that results in the minted stablecoin deviate excessively from its peg, funds from the Treasury will be used to bring the stablecoin back to its peg.
In addition, holders of the OIN token will also be able to cast votes on how to distribute funds in the Treasury.
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