Liquidation

One of the most important use cases for xUSD is it's use in liquidations. The ability for 1 xUSD to liquidate at least $1.00 of unhealthy collateral is key in the overall value proposition of the xUSD token, and assures the stability of the platform. Liquidation is the main risk taken on by vault owners, but will not be a problem if users are attentive to the health of their vaults.

There are several things that will be important to know to understand liquidations

• xUSD is always treated as $1.00 by the protocol, regardless of market price.

• Collateral Ratio (CR) - CR = Collateral/Debt. For a vault backed by $200 worth of Algo, and with 100 borrowed xUSD, the collateral ratio would be $200/$100 = 2. This vault has 2 times, or 200% as much collateral as it has debt. When interfacing with the vaults, this number will always be represented as a percentage.

• Bad debt - If the value of a collateral token falls such that its CR<100%, and the debt is worth more than the collateral it would be considered bad debt. To stop this from happening, liquidations must occur before bad debt is created. If bad debt is created, there is no incentive to liquidate the debt without a liquidator discount.

• Initial Collateral Ratio (ICR) - When creating a vault, this is the minimum CR that is deemed acceptable. This quantity varies by collateral type, but is always greater than or equal to 120%. The difference between the initial collateral ratio and the liquidation threshold is a buffer that the protocol builds in for the safety of people creating vaults.

• Liquidation Threshold (LT)- CRs below the liquidation threshold are open to being liquidated. Liquidation thresholds vary greatly between different collateral types. They're decided at the time that the collateral type is added by CompX, and are a function of the depth of liquidity of a given collateral type. Lower liquidity tokens will change value more rapidly when being liquidated, and so need a higher liquidation threshold to stop the token from creating bad debt for CompX.

• Healthy vault - A healthy vault is defined as a vault that has a CR that's greater than the liquidation threshold.

• Liquidator discount (LD)- This is an additional discount that the the liquidator gets to perform liquidations. For example, when liquidating a vault with a 5% liquidator discount, each xUSD would actually be able to purchase $1.05 in collateral rather than $1.00.

  • Liquidation discount is an incentive for liquidators to monitor vaults and perform liquidations ensuring that they're always buying collateral below market value.

  • The discount also serves as an incentive on the vault owners side, to keep their vaults healthy as it guarantees that the liquidation of their token will result in below market value returns for them.

  • The discount further extends profitability of liquidations even if the vault has gone into bad debt. It would still be profitable to liquidate a vault with a CR of 96%, if the discount is 5%.

A liquidation can occur when a drop in the market value of the vault collateral occurs and causes the CR drops below that collateral's LT. The liquidator repays some of the vault owners debt, and in turn gets to claim an amount of the vaults collateral at a rate that is discounted by that collateral type's LD. In order to protect the owner of a vault as much as possible, only partial liquidations are permitted (unless impossible). Vaults are only able to be liquidated back to the minimum healthy collateral ratio. The liquidator can then sell their acquired collateral for a profit and continue this process until all vaults are returned to healthy status. The specifics of this process can be challenging to get a handle on, so we'll proceed with an example.