Liquidation
Liquidations on Rhombus
This section explains how liquidations work on Rhombus, their benefits, drawbacks, and how they're executed.
Rhombus has a liquidation system in place to minimize default risks and protect lenders’ capital.
What is Liquidation?
Liquidation occurs when a borrower's collateral is sold off to repay their debt if the health factor of their loan drops below 1. Since liquidation is one of the major risks in DeFi lending, borrowers need to regularly monitor their loans and adjust their collateral or repay the loan to avoid this outcome.
Several factors determine how much collateral is sold, such as the liquidation threshold, penalty, the current value of the collateral, and the outstanding debt.
Monitoring Loan Health
Rhombus tracks the health of loans using two key metrics: Loan-to-Value (LTV) ratio and the liquidation threshold.
LTV Ratio: Defines how much you can borrow against your collateral.
Liquidation Threshold: Marks the point at which your loan becomes under-collateralized and is at risk of liquidation.
How Does Liquidation Work on Rhombus?
Loan stability on Rhombus is measured by a metric called the Health Factor, which compares the value of your collateral against your borrowed amount. A health factor above 1 means your loan is safe, but if it falls below 1, Rhombus will sell enough of your collateral to restore the health factor to a safe level.
Liquidation Thresholds:
50% liquidation: When the health factor dips below 1.
100% liquidation: When the health factor falls below a lower, dynamically adjusted threshold.
For example, let’s say you borrowed $10,000 in stablecoins against $18,000 worth of $KAIA. If your health factor reaches the liquidation threshold (e.g., 0.8), Rhombus’ smart contract will automatically sell enough of your collateral to cover the debt. If there's a liquidation penalty (e.g., 5%), the amount of collateral sold will increase to account for that.
When Could Your Collateral Be Liquidated?
To prevent liquidation, it’s important to understand the factors that can cause your health factor to drop below 1:
Volatile collateral: If the value of your collateral drops sharply.
Collateral depreciation: The value of your deposited asset decreases.
Debt increase: The value of your borrowed funds rises relative to your collateral.
Missed interest payments: Failing to meet your interest obligations.
Rhombus helps mitigate some of this risk by placing volatile assets in Isolation Mode (Not available yet).
Who Are Liquidators?
Liquidators are advanced DeFi users or bots that monitor loans eligible for liquidation. They use automated systems to trigger a liquidation when a loan’s health factor drops too low. Liquidators pay off part of the debt and, in return, receive the collateral at a discount, known as the liquidation bonus.
For example, if the liquidation penalty is 5%, half of that (2.5%) is given as a bonus to the liquidator.
Liquidation Bonuses and Risks
Liquidators are rewarded based on the risk level of the collateral. Higher-risk assets come with larger bonuses, encouraging liquidators to actively seek out and resolve risky positions. Rhombus carefully monitors market trends to offer competitive bonuses and ensure the protocol’s health.
Liquidation Process
To execute a liquidation on Rhombus, several inputs are required:
User’s Wallet Address: The borrower’s wallet with a health factor below 1.
Debt Coverage Amount: The amount of debt the liquidator is covering.
Debt Asset: The asset being used to cover the debt, often supported by flash loans.
Collateral Asset: The original asset deposited by the user.
Profit Asset: The asset the liquidator chooses to be paid in, such as native tokens or the underlying collateral.
Steps to Execute a Liquidation
Liquidation is a multistep process that can be automated via bots. Here’s a brief overview:
Verify the borrower’s health factor.
Evaluate if the liquidation is profitable after fees and bonuses.
Use flash loans if necessary.
Perform any necessary swaps.
Complete the liquidation.
How to Avoid Liquidation
To avoid liquidation, you can either repay part of your loan or deposit more collateral. Repaying the loan will significantly improve your health factor, making it the more effective option.
Last updated