Liquidation Process
Liquidations in Unlockd are activated under specific conditions, primarily focusing on the collateral's value in relation to the borrowed amount. This process is essential for maintaining the platform's financial integrity and safeguarding the interests of lenders.
Key Triggers for Liquidation:
Asset Depreciation: Liquidation occurs if the net value of all assets bundled as collateral depreciates, reducing the coverage for the borrowed amount.
Borrowed Cryptocurrency Appreciation: For loans backed by WETH, an increase in the value of the borrowed cryptocurrency can trigger liquidation. This does not apply to Real-World Assets (RWAs) or USD-denominated Token Streams, as they borrow from the USDC Pool.
Accrued Interest: If the accrued interest on the borrowed amount increases significantly, it can lead to a scenario where the loan becomes under-collateralized, initiating liquidation.
These triggers are designed to respond to market dynamics and ensure the loan remains sufficiently collateralized, protecting both borrowers and lenders in Unlockd's ecosystem.
During Unlockd's Liquidation Process, it's important to note that the loan is temporarily restricted from additional borrowing.
This restriction applies even if bids during the liquidation are sufficient to cover the Critical Recovery Threshold (CRT) and raise the Health Factor (HF) above 1.
The borrower will be unable to borrow more until the Borrower Grace Period concludes, regardless of the HF status, ensuring the stability and integrity of the ongoing liquidation process.
Step 1: Auction and Borrower Grace Period
When a liquidation is triggered in Unlockd, it sets in motion a well-defined process that involves both a public auction and the initiation of a Borrower Grace Period.
Public Auction of Collateralized Assets
Upon liquidation trigger, all RWAs used as collateral are placed in a public auction within Unlockd's Marketplace. This auction is open to all participants, providing an opportunity for liquidators to acquire valuable assets.
Liquidators can participate in the auction using their own funds or opt for the 'Bid Now Pay Later' option. This feature allows them to place bids by partially borrowing from Unlockd, offering flexibility in funding their bids.
Initiation of Borrower Grace Period
Simultaneously with the auction's start, the Borrower Grace Period begins. The duration of this grace period varies based on the type of collateralized asset.
This period allows borrowers the opportunity to take necessary actions to potentially recover their assets and halt the liquidation process.
During the Borrower Grace Period, borrowers have the opportunity to undertake corrective measures.
Successful completion of these actions, including a fee to compensate current bidders, immediately terminates the auction and leads to the full recovery of all collateralized assets, effectively halting the liquidation process.
This initial stage of the liquidation process is crucial as it determines the potential recovery of the assets for the borrower and provides liquidators with opportunities to acquire RWAs through the public auction.
The liquidation is halted if the borrower completes the necessary actions to recover the Critical Recovery Threshold (CRT).
Step 2: Bidding
The bidding process during liquidations in Unlockd is designed to maximize the efficiency of debt recovery while offering potential benefits to both the borrower and the liquidators. Here's a closer look at how bidding works in the event of a liquidation:
Starting Bid
The starting bid for each asset in the liquidation auction is set at the lower of two values:
A. The RWA price as appraised by our valuation providers
B. The Critical Recovery Threshold
If a loan includes both high-value and low-value assets as collateral, a significant bid on the higher-valued asset could suffice to cover the CRT.
In such a scenario, successfully covering the CRT with a bid on the more valuable asset could result in the less valuable RWAs being spared from liquidation, as the HF would have been recovered.
This approach allows for more strategic and targeted bidding, potentially benefiting both the borrower and the liquidator.
Binding Bids
Bids are binding and involve an on-chain transaction that consumes gas. This commitment ensures the integrity and seriousness of the bidding process.
Direct Debt Repayment: When a bid is placed, the bidded amount is immediately used to repay as much of the outstanding debt as possible. This means that the funds from your bid do not go into an escrow contract but are directly applied towards debt reduction.
Outcome for Winning Bids: If your bid is the final winning bid, the amount is used to cover the debt.
Cycle of Bids for Debt Repayment: In the event of subsequent higher outbids, the new bid repays the previous bidder and applies any remaining funds to further reduce the debt. This process continues until the auction concludes, ensuring efficient debt repayment.
Automated Return of Funds: If your bid is outbid by a higher offer, the amount of your bid is automatically returned to you, plus incentives if they apply. This process is instantaneous and managed by the protocol, ensuring that the funds are efficiently cycled through the bidding process for maximum debt repayment efficiency.
Auction Dynamics and Borrower Benefits
Continuation of Auction: If an early bid covers the CRT, the auction for that asset continues for the remainder of the Borrower Grace Period, unless the borrower repays to cover the CRT plus bidder incentives. This allows room for higher bids, which could provide additional returns to the borrower.
Additional Proceeds: Any amount bid over the debt recovery target is passed on to the borrower, turning the liquidation into a potentially beneficial situation for them.
In the event of a liquidation auction where the total bids exceed the Critical Recovery Threshold, Unlockd first ensures the loan becomes healthy by covering the necessary amount. Any excess funds from these bids are then directly transferred to the borrower's external wallet, such as MetaMask or another wallet service they use, not to the Unlockd Account wallet.
Incentive for First Bidder
Unlockd incentivizes the first bidder in a liquidation auction. If their bid is outbid by another participant or the borrower saves the loan, they receive a reward worth 2.5% of the bid value of the asset.
This incentive encourages active participation in the auction and ensures fair compensation for early bidders.
Step 3: Auction Conclusion
The conclusion of the auction in Unlockd's liquidation process can occur under different circumstances.
A. Borrower saves the loan
If the borrower successfully applies corrective measures that increase the Health Factor (HF) above 1, the auction is immediately terminated.
In this scenario, funds are returned to the bidders, assets are recovered by the borrower, and any applicable incentives are paid out.
If bids on certain assets are sufficient to cover the CRT, assets without bids are removed from the Marketplace. However, the auction continues for the assets with bids unless the borrower recovers the HF, and pays fines and incentives. At that point, all assets are removed, and funds are transferred back to bidders.
B. Insufficient Borrower Action
If the borrower does not take action to restore the HF, and bids are sufficient to cover the CRT, after the Auction ends, thus ending the Borrower Grace Period:
The winners need to manually claim the assets. This consumes a bit of gas.
The assets with successful bids are transferred to the respective winners.
Assets without bids are returned to the borrower.
Any excess funds from the bids, after covering the CRT are returned to the borrower.
Any new loan potentially created via 'Bid Now, Pay Later' is initiated as a standard loan.
C. Inadequate Bids to Cover CRT
If the Borrower Grace Period concludes and the accumulated bids are insufficient to cover the CRT, this marks the end of the auction process.
Assets that have received bids during the auction are available for claim by the highest bidders, regardless of whether these combined bids reach the CRT.
In the cases that the combined bids do not reach the CRT, Unlockd activates External Liquidation Gateways.
These gateways are utilized to attempt liquidating the remaining assets that were not successfully bid on during the auction.
The aim is to recover the CRT through these gateways, ensuring the minimum financial obligations of the loan are met despite the auction not fully covering the CRT.
Step 4: Liquidation via External Liquidation Gateway powered by Smart Liquidation Algorithm
When the Borrower Grace Period ends without sufficient bids in Unlockd's marketplace auction to cover the CRT, the Smart Liquidation Algorithm, in conjunction with External Liquidation Gateways like Reservoir, takes over the process.
Smart Liquidation Algorithm's Role
The Smart Liquidation Algorithm aims to recover the minimum amount of debt needed to elevate the Health Factor (HF) above 1, in other words, the CRT, thereby saving the loan from liquidation.
It strategically selects assets for liquidation based on the highest available bids in External Liquidation Gateways, focusing on the most effective way to meet this targeted debt recovery.
The Smart Liquidation Algorithm is designed to minimize the number of assets liquidated, reducing adverse effects on the borrower's remaining assets and lessening market sell pressure.
By choosing assets for liquidation based on their bid values in External Liquidation Gateways, the algorithm aims to recover the essential amount with minimal impact, thus preserving maximum value for the borrower.
Integration with External Liquidation Gateways
In cases where the marketplace bids are insufficient, the algorithm utilizes Reservoir to find the best available offers for the assets, facilitating instant liquidation at market-driven prices.
This integrated approach aligns with Unlockd's commitment to an efficient and fair liquidation process, balancing the need to cover outstanding debts while minimizing the impact on borrowers.
For an in-depth understanding of Unlockd's Smart Liquidation Algorithm and its role in the platform's liquidation process, please refer to our comprehensive documentation.
In conclusion, the Liquidation Process in Unlockd is meticulously designed to ensure fairness and efficiency in managing under-collateralized loans. From the initiation of the Borrower Grace Period to the strategic use of the Smart Liquidation Algorithm and External Liquidation Gateways, each step is crafted to balance debt recovery with the protection of borrowers' interests.
This comprehensive approach underscores Unlockd's commitment to providing a secure, transparent, and user-centric platform for RWA-backed lending.
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