LUSD Liquidations during 21–24/1: Lesson Learned
Tldr: the B.AMM executed over $6m of liquidations with 10% profit, however due to temporary LUSD price depegging it maintained an ETH exposure for longer duration than expected. A new B.AMM that takes LUSD price into account is now live, and users can migrate their deposits there.
Introduction
The dip in Ethereum price between the dates of 21–24th of January triggered over $20m in ETH liquidations in the Liquity stable coin platform of which $6m were liquidated by B.Protocol’s pool (the proportional part of B.Protocol in the stability pool).
Our backstop automated market maker (B.AMM) handled these liquidations in a profitable manner, however due to deviation in LUSD/USD price it maintained a non negligible ETH exposure for almost 3 days. In this post we analyze the series of events and describe a mitigation we implemented for future liquidations.
As the B.AMM is non custodial and non upgradable, users need to actively migrate to the new implementation, and in the last section we explain how to do it.
Analysis of events
The B.AMM is designed to liquidate under-collaterlized positions at 10% discount, given by Liquity,and sell the seized ETH back to LUSD with discount over market price.
At the dates of 21–24th, the B.AMM facilitated over $6m of liquidations, and offered the seized ETH for sale with a discount of around 0.5% over market price. The discount was dictated by the A parameter that was set to 20 (the minimal possible value) and by the fact that the imbalance of the inventory (the ratio of ETH to total inventory in the B.AMM) was 6%. At this point of time, a further 10% crash in ETH price would result in 0 loss (as the $6m were bought with 10% discount) and 20% decrease would result in 0.6% loss.
However during this time period, LUSD was traded above 1.01 USD per LUSD, and in most of the time even over 1.02 USD. As a result, the B.AMM was effectively trying to buy LUSD for 1.005 USD, while its market price was 1.02 USD.
Eventually, after 3 days, the price momentarily stabilized to 1.005, and 90% of the 6% imbalance was closed. The additional 0.6% imbalance was closed 4 days later.
The analysis shows that the imbalance was closed roughly after ETH price reverted to the price it had during the liquidation, and the increase of ETH price might have contributed to LUSD re-pegging. However we believe that it is an undesired behavior, and the feedback we got from our users is that they would favor closing the ETH exposure sooner, rather than later.
Mitigation
We expect LUSD to be traded above $1 also in future dips. This is mostly because in bear markets people are willing to pay a premium in order to close their ETH long positions, and as a result pay above $1 per LUSD.
Luckily an on-chain price feed for LUSD/USD is now available, and thus an easy mitigation is to take LUSD/USD price into account when offering LUSD for sale.
When LUSD is traded above $1 it effectively reduces the expected liquidation profit, however reduces the risk.
In the recent dip LUSD was temporarily traded at a peak over 1.07 USD, and in bigger market crashes it could be traded even at 1.1 USD. At these levels the liquidation process becomes unprofitable, and hence we cap the maximum discount over USD price to 4%. This limitation increases the expected profit, but as always higher profit comes at the expense of higher risk.
What should users do?
B.Protocol’s LUSD B.AMM is non custodial and such non-upgradable. Hence, we cannot change the currently deployed B.AMM, and users should actively migrate their account if they wish to move to the new implementation. In order to migrate, a user must withdraw her LUSD deposits from the current B.AMM and deposit it into the new B.AMM.
The new B.AMM was audited by Kurt Barry from Fixed Point Solutions, and is featured now as the default option in our website at https://app.bprotocol.org/liquity.
The existing B.AMM contact remains operational (forever) however we will deprecate it over time in the front end. It is accessible under the “Legacy” tab in the website.
About B.Protocol
B.Protocol is building a Backstop DeFi primitive, unlocking higher capital efficiency in the ecosystem. By democratizing liquidation systems it shifts MEV and bot profits to the hands of the community.
Lending platforms that integrate with B.Protocol democratize their liquidation system, provide a stronger safety net to their lenders, and enable higher collateral factors for its borrowers.
With B.Protocol, anyone can participate in the lucrative business of liquidations, tapping into the $1B/Year market of DeFi liquidations, on its growth path to the $100B/Year of liquidations made in CeFi.
