Liquidation is a bug, not a feature.
It is arguably the worst UX of leverage-based products. Most likely you are forced to sell your collateral at the bottom. And nobody wants to sell the bottom, only for the price to rebound shortly after.
Liquidations are the biggest UX Problem of on-chain leverage
Due to how transactions are processed in blockchains, an on-chain position’s liquidation trigger price is often much higher than the bankruptcy price, to account for slippage/congestion during liquidations,
What is the bankruptcy price? It is the price at which your margin is depleted. If your position is 10x levered, your position’s bankruptcy price is -10% of your entry price. For 5x, -20%, for 3x,-33%, etc.
Ok, so a trader should get liquidated at their bankruptcy price right?
Wrong.
For leverage longs(or shorts), the actual liquidation price is much higher(or lower) than the bankruptcy price. This spread is effectively the ‘liquidation fee’ lost to market makers and MEV bots. Its presence means not only are you forced to sell your position, but you are forced to sell it at a lower price than the current fair market price.
Take a look at the simulated position above, from an oracle-based liquidation-enabled margin trading protocol. A 10x levered position will be liquidated at -4% of current prices instead of -10%(the bankruptcy price).
The remaining 6%(6*10 = 60% of the trader’s margin) will be lost to MEV bots!
You can think of the 6% as ‘insurance against worst-case liquidity scenarios’. They exist as a backstop against situations when transactions are slow/congested, where prices can drop faster than oracle updates, leading to protocol insolvencies.
As such, on-chain native high leverage is impossible when coupled with oracle-triggered liquidations.
It gets worse. Sometimes, a cartel will hunt your position even if your position is (very)far above your liquidation price.
This penalty system, meant to insure against worst-case liquidity scenarios, can and will be exploited by malicious parties to forcefully hunt down positions, causing so-called scam-wicks.
Poor lad’s 2x long got hunted at the pico bottom. PEPE has since 10x-ed from his liquidation price.
For a low liquid pair like PEPE-USDC, it is common for traders like the one above to be forced out of their positions with double-digit % scam wicks.
The Limitless Way
In Limitless, however, there are no liquidations. No liquidation fees, penalties, scam wicks, or margin requirements. Traders can HODL their position under any price action.
Technical details on how this works can be found in our docs. But briefly put, Limitless rehypothecates existing Uniswap V3 spot liquidity and allows ‘the trader’s loss after liquidation price to be absorbed by LPs in the form of impermanent loss’.
Instead, traders pay premiums, akin to funding rates, to keep their position open indefinitely irrespective of price movements.
This results in a win-win scenario for both traders and LPs as
- traders now never have to worry about forced liquidations
- LPs earn strictly higher yields compared to spot dexes because of the trader’s premium. For the first time, they are paid to risk impermanent loss, which is a risk assumed by LPs all the time but is never compensated for.
The diagram above presents a simple illustration of how liquidation-free trading works. The trader’s position is the collateral of the debt borrowed from LPs. The collateral amount(which is the position size) is guaranteed to always be able to pay back the LP in both tokens. In the example above, either in ETH or USDC.
We are the first to implement this mechanism and have it live on Arbitrum (invite only beta).
Conclusion
Thanks for reading our blog post on liquidation-free trading, the first of its kind in DeFi.
For more info check out our docs and keep updated on twitter(if you search hard enough, you might be able to find invite codes to our private beta).
Also don’t forget to join our discord check out our Galxe to join as early members of our community.
