Welcome to another article on Aura, or How I Learned To Stop Worrying And Love Liquidations.
Last week we went over what makes Aura the most autonomous, dynamic protocol in existence. Now it’s time to talk about our Savings product and what makes our multilayer liquidation engine extremely resilient.
There is an untold amount of ways in which a position can be liquidated. Perhaps the one most are acquainted with is Aave/Compound’s. As soon as a position becomes eligible for liquidation, a searcher bids on it with the correct amount of debt, unlocking collateral worth that much + the penalty. You may have also heard about Maker’s collateral auctions, or Liquity’s stability pool. More experimental ways have tried to use AMMs to do it smoothly.
What if we had them all, with specific rules for when to use each?
The problems
With traditional liquidations it’s most profitable to liquidate when the penalty function peaks. Once it does, the incentive is simply no longer there—no one liquidated at the peak of the position’s profitability, why would they at a lower level?
Stability pools address this issue. However, being at the forefront of liquidations might introduce a risk some may be unwilling to bear, which in turn may result in lower liquidity for the stability pool for the scale we’re going for. We want Aura protocol to appeal to everyone: retail, crypto natives, and institutions alike.
Maker’s Dutch auctions are an ingenious way to spread out the selling pressure in order to be able to handle the massive liquidations required at their scale. However, they use a fixed close factor which is suboptimal as it is more likely to trigger liquidation cascades.
Put on your thinking hat and let’s analyze the life cycle of an Aura liquidation.
The Life Cycle
Searchers
You open a position. Aura calculates your Liquidation Threshold at 82% LTV based on its composition. Your current LTV is 75%—you like to live dangerously and it has paid off until now.
Some days have elapsed and unfortunately your portfolio performed poorly. Your CDP’s LTV is now 82% and has become eligible for liquidation.
Remember last week’s article where we mentioned a range for the liquidation penalty and the close factor? For the sake of this demonstration, let it be between 3% and 12.5%, and 30% and 100% respectively. This means that if you were to get liquidated at 82% LTV the close factor would be 30% and the penalty 3%. If it were to happen here’s what your numbers would look like:
If no one chooses to liquidate at this LTV with the penalty at 3% and the close factor at 30%, these two numbers will continue to climb and peak at 100% and 12.5% respectively when your LTV reaches 88.88%.
If at this point, the peak of profitability of the liquidation function, the CDP still hasn’t been liquidated, then anyone is able to liquidate it via… the stability pool.
Stability Pool & Savings
The stability pool is a contract where users interested in safeguarding the protocol’s solvency deposit to get a return on their capital. In exchange for the risk they undertake, they are rewarded with interest from borrowers, as well as profitable liquidations, and because Aura is a cross margin system, these liquidations would result in a discounted acquisition of a basket of collateral assets.
The difference between Liquity’s OG Stability Pool and ours is that here, stability providers receive interest from borrowers, and the collateral assets acquired are more diverse. Additionally, we add automation services for the smart swapping and compounding of these assets via Sandclock.
Let’s take a look at how it works under the hood.
The above infographic does not mention interest gained from borrowers and makes use of a Dutch auction to sell the acquired collateral over time in order to showcase the mechanism’s potential profitability. Sandclock can automate this as mentioned above. However, this is strictly optional, and a user can use the stability pool to dollar cost average into discounted crypto assets, in which case their synthetic asset holdings will decrease with each liquidation in exchange for tokens.
There is a problem though. What happens if the stability pool does not have enough capital to liquidate the collateralized debt position?
Enter, Socialized Liquidations
Inspired by Liquity’s Stability Pool architecture, when there isn’t enough capital in the stability pool to safely liquidate a position, the protocol will redistribute all the collateral in this CDP and all its debt proportionately to all CDPs in the system with these collateral assets.
Because of its ruleset, this mechanism mitigates the likelihood of bad debt ever accruing to the protocol and allows the protocol time for “buying pressure” to accumulate.
… And this is it. The protocol’s Savings Product which ties in with its 3-layer Liquidation Engine.
Next week is an exciting one. We will talk about supported collateral assets, how we’re going to mitigate liquidity crunch and turbocharge yield generation all in one fell swoop! See you then.
