Introducing Liquidations
Ensuring the health of our protocol is integral to allow the Ratio Finance DAO to thrive. We have, to date, exclusively accepted stable-stable pairs to minimize the risks of liquidation. USDr is an overcollateralized form of debt, and thus the TVL of Ratio Finance must always be significantly more than the USDr in circulation.
Now, the introduction of liquidations will continue to help us keep the Ratio Protocol healthy for our users, while simultaneously allowing us to expand into accepting LP tokens with volatile underlying assets in addition to many other innovations.
Our liquidation engine involves real-time monitoring of the health of each user’s vault, which relies on verifying the value of collateral deposited into Ratio Finance. Since LP tokens form the collateral for minting USDr, it is necessary to constantly check the value of the collateral based on the LP token price, which is a function of Total Value Locked (TVL), Volume, Individual Prices, and Price Slippage.
In Liquidity Pools, the starting or ideal balance of assets is in equal proportions. When a transaction takes place, the proportions of assets in the pool changes, as one asset is exchanged for another.
Dynamic Risk Management
For each Collateralized Debt Position (CDP) available on Ratio, there is a Collateralization Ratio in place based on the risk rating of the liquidity pool which is determined by the Ratio Risk Ratings (RRR). For example, the liquidity pool of USDT-USDC on Saber is rated as ‘AA’ according to the RRR, for which a Collateralization Ratio of 110% is in place.
This means that a user would need to deposit $110 worth of collateral, in order to mint $100 worth of USDr.
Protocol Risk Metrics
Due to the volatile macro-environment, it may occur that the Collateral Value goes below the Collateralization Ratio. As a result, a liquidation process will be initiated to protect the protocol and its users from the potential downside.
We encourage users to continuously monitor the health of their position by means of the Collateral Deposited to Debt;
Whereby, the Maximum Borrowable Debt in USDr is given by;
When a user is in an unhealthy position (meaning that the Collateral to Debt is less than the Collateralization Ratio), the protocol has the right to liquidate the collateral deposited by the borrower. In this case, the protocol takes a portion of the collateral deposited by the borrower and sells it. The proceeds of this sale are converted into USDr which is then used to pay back a portion of the user’s debt. This reduction of the debt causes an increase in the user’s Collateral to Debt Ratio, which returns their position to a more healthy state.
Since the protocol’s interest is aligned with that of the user, Ratio Finance has an additional cushion in place to protect our borrowers in the event of liquidation. This cushion is called Delta, and allows the protocol to leave the borrower’s debt in a much healthier position after liquidation.
This effectively means that, in a liquidation event, the protocol will not unwind and liquidate the full position of the borrower, but instead, just a portion of the collateral will be liquidated and the borrower will return to a healthy position.
Repay to be Safe
During periods of high volatility, we encourage borrowers to constantly monitor their Collateral to Debt Ratio and Position’s Health. In the background, Ratio’s Risk Engine is periodically updating a formula called the Dynamic Collateralization Ratio for each of the open vaults. This ratio accounts for changing market conditions (for a detailed explanation of its calculation, please visit our Gitbook).
It is easy to calculate what amount needs to be repaid to avoid liquidation. The repay percentage is simply the difference between Collateral to Debt and Collateralization Ratio.
We provide borrowers with two options to repay their debt, namely;
- Borrower goes to the open market and buys some USDr and repays on the platform
- Borrower mints more LP tokens and deposit directly on the platform
These methods allow our users to increase their Collateral to Debt, and avoid Liquidation.
Partial Liquidation
As previously stated, in a liquidation event, the Ratio Protocol will typically not unwind and liquidate the full position of our users; instead just a portion of the collateral will be liquidated and the borrower will return to a healthy position.
Fees takes into account the urgency of the protocol to liquidate and unwind the LP position at some cost to account for trading fees and slippage. By doing this small readjustment to the borrower’s position, Ratio’s Liquidation Engine is recalibrating the position of the borrower, ultimately allowing for risk-on setting.
Risk Epochs and Full Liquidation
Ratio’s Risk Engine periodically checks and updates each user’s vault. These checks occur in epochs with a duration determined by the Ratio DAO.
Currently the Risk Epochs have a length of 10 minutes which means that every 10 minutes borrowers’ positions are assessed and set for repayment, partial liquidation or full liquidation.
We should note that Ratio’s Liquidation Engine is designed to avoid full liquidations unless it is absolutely necessary.
However, full liquidations can happen in periods of great volatility.
As an example;
Tom is a borrower at epoch 0, and has a position that should be repaid to go back to a healthy position. If the debt is not paid within two epochs, then at epoch 3, Tom will get partially liquidated for X amount of his collateral.
Now suppose that Tom’s debt value is tanking in a high volatility event. If the debt is not repaid and the minimum liquidation percentage changes considerably from epoch to epoch, then at epoch 3, Tom will get fully liquidated for the total amount of his collateral. By doing so, we will be securing the protocol in case of, say, a depegging of stable assets or black swan events.
Conclusion
Essentially, the introduction of liquidations promotes the health and sustainability of the Ratio Protocol, and acts as a measure for our users to continuously make risk-conscious decisions. It also, crucially, allows us to accept volatile pairs as collateral to mint USDr. This means that our users will soon be able to enjoy leveraged yield farming for various volatile pairs and non-stable pairs such as sSOL/SOL, RAY/USDC, and mSOL/SOL. We are thrilled at this possibility as it ushers in a new way for Solana users to gain access to leveraged yield opportunities at risk appetites of their choosing!
For a more technical overview, read our GitBook.
Connect your wallet and click on the 🔔 on app.ratio.finance to subscribe for liquidation alerts! ⏰
Learn more about Ratio Finance by visiting the below links:
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Ratio Finance’s mission is to enhance liquidity and De-Risk DeFi, to allow both retail and institutional investors to participate in these novel markets.
Our long-term vision is to be the Risk Rating Agency for all of Decentralized Finance.
