Liquidations

Introduction to the Concept of Liquidation

Liquidation is a critical process within the PhoLend platform that occurs when the collateral securing a loan is no longer adequate to cover the amount owed, as evidenced by a health factor that falls below the threshold of 1. This situation can arise if the market value of the collateral decreases significantly or if the borrower's debt increases. During liquidation, a portion of the borrower's debt—up to 50%—is automatically settled by converting the collateral into liquid assets, with the addition of a liquidation fee.

Liquidation Penalties and Fees

The specific penalties associated with liquidation vary based on the type of collateral pledged. Each asset class on PhoLend is accompanied by distinct risk parameters, which include the liquidation fees applicable to that asset. These fees are designed to compensate liquidators for the risk and effort involved in the liquidation process while also discouraging risky borrowing behaviors.

Detailed Examples of Liquidation Scenarios

• Example 1: Consider a user, Bob, who has deposited 100 units of cryptocurrency XFI and has taken a loan of 50 XUSD. If Bob's health factor deteriorates below 1, a liquidation process could be triggered wherein up to 25 XUSD (representing 50% of the loan) may be liquidated. A liquidator would then be entitled to acquire approximately 26.25 XFI from Bob’s collateral, which includes a liquidation bonus of 5%.

• Example 2: In another scenario, Bob might deposit a mixed collateral of 50 XFI and 40 MPX, against which he borrows 50 XUSD. If the health factor for this arrangement falls below 1, a liquidator might prefer to liquidate the MPX rather than the XFI, due to a higher liquidation bonus of 15% on MPX. In this case, the liquidator repays 25 XUSD of Bob’s debt and claims 28.75 MPX from the collateral.

Strategies for Mitigating Liquidation Risks

To avoid the undesirable outcomes of liquidation, borrowers are advised to proactively manage their loans. Enhancing the health factor by depositing additional collateral or repaying part of the debt can significantly mitigate the risk. Repayment of the loan principal is often more effective in improving the health factor than simply increasing the collateral volume. Regular monitoring of the health factor, ideally maintaining it well above a factor of 2, is crucial in preventing liquidation. Borrowers should also remain vigilant about the potential impact of stablecoin fluctuations, as these variations can unexpectedly affect the health factor.

Participation in the Liquidation Ecosystem

The liquidation ecosystem on PhoLend is open to all users and presents an opportunity for those equipped with advanced technical tools and strategies. Participation in liquidations is highly competitive, with many users employing automated systems and bots to optimize their chances of successfully executing liquidations. This dynamic part of the ecosystem not only provides financial incentives in the form of bonuses but also plays a vital role in maintaining the platform's overall financial stability by ensuring that loans are appropriately collateralized at all times.