Liquidations on Nolus Protocol
DeFi Leases, among other primitives involving lending, have liquidation mechanisms to ensure that lenders and the Protocol do not suffer from bad debt and losses. In this post, we introduce the concept of liquidations, the benefits of partial liquidations, and illustrate how a liquidation on Nolus Protocol would take place.
How Can a Borrower on Nolus Protocol Get Liquidated?
When a borrower opens a DeFi Lease, they must provide collateral to secure the facility. On Nolus Protocol, borrowers will borrow USDC from the Liquidity Provider’s Pool which is used to acquire the desired asset through Osmosis or any future integrated decentralized exchange.
DeFi Leases will have a parameterized liquidation threshold. Currently, liquidations are triggered when the value of the debt is equal to 90% of the total position value. If the loan’s value grows beyond this threshold, the Protocol will automatically sell some of the collateral to repay the loan.
Liquidations on Nolus Protocol are likely to occur due to a sudden, or prolonged, drop in the value of the borrower’s collateral. This would bring the Loan-to-Value (“LTV”) percentage closer to the liquidation threshold referred to above.
Note that interest accumulated also increases the total borrowing and therefore increases the LTV of any given DeFi Lease.
What Are Partial Liquidations and How Do They Benefit Users?
Many lending protocols liquidate a borrower’s entire position immediately after it exceeds the maximum LTV percentage. This is especially damaging to borrowers who suffer more economic harm than necessary.
When a position is liquidated, it is liquidated at a discount to incentivize third parties to liquidate a vault that is below the required health level. Liquidating all collateral means a more significant amount of value is sold at a discount. As a result, partial liquidations have been introduced in many lending protocols to offer borrowers a more attractive venue to borrow funds.
Partial liquidation is the process in which collateral is taken in part and liquidated to maintain a healthy LTV percentage for a position. This will give a borrower a greater amount of time to recover their position to protect against future liquidations, thereby maintaining a higher amount of collateral and a lower amount of collateral lost to discounted liquidations.
Illustrative Example — Getting Liquidated on Nolus Protocol
For this example, we will assume that Alice opens a DeFi Lease and seeks 140% in financing on her collateral. The current price of $ATOM at $10.00.
Alice deposits 1,000 $ATOM in collateral and receives 1,400 $ATOM in borrowings. At the point of inception, the value of Alice’s collateral is $10,000, and her borrowing is $14,000 (the value of the ATOM that she borrowed).
This helps calculate an important metric: the fixed value of initial borrowing divided by the current value of assets in the DeFi Lease. At inception, this is 58.3% (calculated as $14,000 / $24,000). As the value of $ATOM falls, this metric increases slowly towards the liquidation thresholds.
Partial liquidations occur when this metric reaches 90%. Knowing this, we can calculate ahead of time the price at which we would suffer a partial liquidation if we do not interfere ahead of time. For those of you not too keen on maths, don’t worry — we’ve got you!
Step 1: Calculate the value of assets in the DeFi Lease at the 90% metric:
$14,000 [the value of the loan at inception] / 90% = $15,556
Step 2: Calculate the price of one unit of the asset:
$15,556 / (1,000 + 1,400) [the total number of ATOM in the DeFi Lease] = $6.48
Step 3: Calculate the percentage decrease in price:
($6.48 — $10.00 [original price of ATOM]) / $10.00 = -35.2%
If a DeFi Lease declines to this position, a partial liquidation occurs until the DeFi Lease returns to the healthy liability threshold. This parameter is currently set at 83%.
Closing Thoughts
Nolus Protocol aims to provide a safe environment for lenders. One of the ways in which this is done is through partial liquidations that reduce the amount of economic harm imposed on borrowers during an adverse market movement.
This is important as lenders are the beating heart of the Protocol, and increases in borrowing help continue the flywheel that will make Nolus Protocol attractive for depositors and cheap for borrowers!
#GetToNolus better! 👇
