Loan lifecycle & Liquidations
This page summarizes the different steps of a loan during its existence.
Last updated
This page summarizes the different steps of a loan during its existence.
Last updated
The borrower needs to first supply a supported asset as collateral in a Liqwid market to be able to open a loan. Each supplied asset will unlock some value the user may borrow against depending on the assets assigned collateral factor.
Once the asset type and amount are selected, the borrowed assets are transferred from the market directly to the borrower’s connected wallet. The maximum amount to borrow is determined by the collateral factor set by the margin system for the asset type the user supplied as collateral.
Example: In the situation where 1 ADA has an exchange rate of 2 USD, the borrower is depositing 1,000 ADA as collateral. The market value of his pledge is USD 2,000 and the collateral factor for ADA is 70% x USD 2,000 = USD 1,400. This is the maximum amount to be borrowed before the user reaches negative account liquidity and risks liquidation.
There is a 1% loan origination fee to open a loan in the Liqwid protocol. These fees are currently divided 50-50 between distributions to LQ stakers and the DAO treasury.
You must repay your full loan in the asset you borrowed. For example, if you borrow 100 ADA you will pay back 100 ADA principal + interest accrued when you repay the loan.
During the lifecycle of a loan, the liquidity cushion could reach zero or the account liquidity approaches negative. This occurs when the value of the collateral is falling relative to the value of the borrowed asset plus accrued interest.
To actively remove the credit risk of the protocol, materialized by the exposure to defaulting loans, a liquidation incentive has been created. The mechanism is that any user (liquidator) can bring the borrowed asset and repay the default loan using either a liquidation bot or directly within the Liqiwd app UI. During the liquidation transaction the liquidators assets will be exchanged against the seized collateral of a defaulting loan to repay the original asset that was borrowed. The liquidator will also receive the collateral at a discount determined by the liquidation bonus parameter. Liquidation bonuses for each asset are displayed in the market's details page. Each market has a liquidation bonus parameter applied. This means successful liquidators receive a default borrower's collateral at a discount when they repay their underwater loan in part or full. E.g. the ADA market has a 10% liquidation bonus, when a liquidator repays a default ADA loan there is a 10% bonus applied on the total collateral they receive. *Note: the liquidation bonus is a governance configurable parameter used to incentivize liquidators/bot operators to repay underwater loans. The parameter is subject to changes based on market conditions. Liquidators should pay attention to discussions on the Liqwid governance forum for liquidation bonus parameter updates and liquidation bonus parameters set for new markets.
Example: In the situation where the ADA exchange rate drops from 1 ADA = 2 USD to 1 ADA = 1.5 USD. The market value of the collateral is USD 1,500 and the collateral value is USD 1,050. If the borrowed amount (nominal+interest) is greater than the adjusted collateral value (USD 1’050), the loan will be liquidated.
Any user can initiate the liquidation of a loan having a health factor below 1. These loans are shown in the app UI page "Liquidation". Liquidators can also repay defaulting loans using the open source liquidation bots.
Once a wallet is liquidated, the seized collateral is exchanged against the assets from the corresponding liquidators wallet. The discounted collateral price used for the liquidation allows the liquidator to directly seize collateral at a 10% discount (ADA market is currently set to 10%). The liquidation bonus is claimed entirely by the successful liquidator, the protocol does not take any fee or margin from liquidators during this process.
