AN INTRO TO LIQUIDATIONS ON ANCHOR PROTOCOL
Before getting into liquidations and how they work, it’s important to understand the forces at play creating the conditions for a liquidation and what is being liquidated.
This post covers the basics and will give you an understanding of the mechanics and the roles involved.
Let’s start with what is being liquidated:
MEET ANCHOR, THE LENDING PLATFORM
Anchor Protocol is a money market. The platform allows users to borrow one asset when they provide another as collateral against the loan. The collateral is locked up as surety against the amount lended.
WHY WOULD SOMEONE DO THIS?
Borrowers offer assets as collateral when they wish to put their value to work without selling them. By borrowing against the assets they hold, they are able to use the loan, without selling their assets to generate capital.
Borrowing makes sense if the borrower wants access to capital and the freedom to use the borrowed capital however they like.
STABLES AND NON-STABLES
Anchor lends UST, a stablecoin pegged to the value of a dollar. $1 is always worth 1 UST (pretty much).
This is what Anchor loans to borrowers.
In exchange, borrowers stake non-stable assets. Currently, this is only bLUNA or bETH, but is likely to include non-stable crypto from other chains thanks to the magic of bridges.
Lending out UST is a risky undertaking for Anchor, and so they expect borrowers to reduce that risk by providing assurance in the form of collateral. This collateral currently takes the form of LUNA or ETH which are bonded into bLUNA and bETH.
Anchor allows borrowers to withdraw up to 60% of the value of the collateral deposited.
A change in the value of the staked asset means the total value of the collateral provided by the borrower can potentially dip below the required 60% of the amount borrowed. When this happens the loan becomes “at-risk” and can be liquidated.
WHAT DOES LIQUIDATION MEAN?
“Liquidation” sounds intimidating but it’s a simple concept and an essential part of maintaining a healthy lending system.
Liquidators ensure that suppliers of funds are not put out of business by losing capital to bad debt, and by keeping lenders solvent, liquidators ensure there’s capital available to would-be borrowers.
They keep the cogs of the system turning.
When a loan is at-risk, a liquidator may opt to liquidate the loan. They are, in effect, stepping in to pay the difference between the total value of the collateral and the total value of the required minimum percentage of the amount borrowed, in order to keep the system running.
WHAT LIQUIDATORS GET IN RETURN
Liquidators repay the shortfall on the collateral to the lender on behalf of the borrower.
Remember that the loan is in a stablecoin (UST) and so the value of the collateral is measured in UST. The liquidation is therefore paid in UST.
Once an at-risk loan is successfully liquidated, the lender (in this case, Anchor) gets back the UST they loaned out, and the borrower has the UST they borrowed. The collateral put up by the borrower becomes the property of the liquidator.
THE BENEFITS OF BEING A LIQUIDATOR
Liquidators are recompensed for their service by means of a premium. This is effectively a discount on the price of the Non-Stable asset used as collateral to secure the loan.
This discount rate on ORCA can vary from 1% to 30%. Bids can be made at any of these premiums.
Market forces mean that liquidators accepting a smaller premium (a lower discount) will be the first to access at-risk collateral. When all the bids placed at lower premiums have been filled, bids at higher premiums will be accessed.
For now, it’s important to understand the mechanics:
- A borrower puts up collateral in the form of a Non-Stable asset to secure a loan from Anchor.
- The loan is made in the form of a stable asset — UST.
- The loan amount is a maximum of 60% of the value of the collateral.
- Should the collateral (or bonded asset) value fall to a point where the loan exceeds the threshold, it is deemed at-risk.
- When an at-risk loan is liquidated, the lender is paid in UST and the borrower forfeits their collateral.
- The liquidator who repaid the shortfall in the collateral value to the lender is recompensed with the collateral itself.
If you’ve got your head around that, you’re ready to move on!