Liquidation is a process that triggered once the position's collateral asset price falls to the liquidation price. During the liquidation process, a liquidator will execute the liquidation by paying the amount of WEN debt in exchange for the ownership of the equivalent value of the collateral asset. The borrower of this liquidated position keeps the amount of WEN borrowed. However, the borrower loses the amount of collateral asset deposited. Therefore, it is crucial for borrowers to maintain their positions above the liquidation price.
The liquidation price is the price of the collateral asset that will trigger the liquidation. When the price of the collateral asset drops to the liquidation price, the position will be liquidated. A position will only be liquidated when it drops to the liquidation price.
The liquidation fee is the incentive fee given to the liquidators performing liquidation. From the borrower's perspective, the liquidation fee is already included in the calculations when quoting a liquidation price for the respective collateral assets. When the borrower's liquidation price is reached, the position will be liquidated. From the liquidator's perspective, the liquidation fee is the discount a liquidator gets when buying collateral flagged for liquidation.
To avoid liquidation, you can increase your position health by depositing more collateral assets or repaying part of your debt. You should beware of your position health and liquidation price and adjust them according to your risk appetite when opening your position. Also, it's essential always to keep monitoring your position health to avoid liquidation.
Here is an example for you:
If Alice deposits 100 STC and borrows 50 STC worth of WEN. When Alice opens this position, the current price of STC is $1, and the liquidation price for this position is $0.5. When the market price of STC drops to $0.5, Alice's position will be flagged for liquidation. A liquidator can repay the amount of WEN debt in Alice's position, including the amount of WEN borrowed, borrow fee and accrued interest= 50 WEN + borrow fee + accrued interest. In return, the liquidator will receive the ownership of the equivalent value of the collateral asset at a discount rate. After the liquidation, Alice will be able to keep her 50 WEN, however, she will lose ownership of her STC.
Market risks can be mitigated through WENWEN Protocol’s risk parameters which define collateralisation and liquidation rules. Each collateral asset has specific values related to its risks, therefore, risk parameters for every collateral asset will be adjusted accordingly.
The Maximum Collater Ratio or Loan to Value (LTV) ratio defines the maximum amount of WEN that can be borrowed with the collateral asset. It’s expressed in percentage. For example: When the Maximum Collateral Ratio is 70% for the STC borrowing pool, for every 1 STC worth of the STC deposited, borrowers will be able to borrow 0.70 STC worth of WEN.
The liquidation threshold is the percentage at which a position is defined as undercollateralised, and flagged for liquidation. For example, a Liquidation threshold of 80% for the STC borrowing pool means that if the value rises above 80% of the collateral, the position is undercollateralised and could be liquidated.
The delta between the Loan-To-Value and the Liquidation Threshold is a safety cushion for borrowers.
Sufficient incentives are needed for the liquidators to execute liquidation in adverse market conditions. The liquidation fee is the incentive fee given to the liquidators performing liquidation. From the liquidator's perspective, the liquidation fee is the discount a liquidator gets when buying collateral flagged for liquidation.
For each position, risks parameters above enable the calculation of the position health. Using STC pool as an example:
When the position health of the position is flagged as dangerous, it may be flagged for liquidation. When the position health is closer to 0, the position is more likely to be liquidated.