Liquidation

Liquidation Scenarios

Collateral will be liquidated in two scenarios:

1. Collateral Value Depreciation: Liquidation is governed by a Discreet Log Contract (DLC), which is established during the Loan Assignment process. The Oracle provides signed attestations of BTC’s price at predefined intervals. If the Oracle reports a drop in the BTC price that causes the loan’s Health Factor to fall below 1, collateral must be liquidated. The DCA uses the Oracle’s attestation signature to unlock the pre-signed CET and its adaptor signature, allowing the DCA to spend the BTC collateral according to the terms of the CET. This action initiates the liquidation process, with the collateral sent to the DCA for liquidation. The DCA uses the oracle attestation's signature to unlock a pre-signed CET's adaptor signature and spend the BTC collateral according to the CET's terms. This action triggers the loan collateral's liquidation. Collateral is sent to the DCA for liquidation.

2. Default: If the loan is not repaid by the Maturity Time, the borrower is considered to be in default. There is a timelock in the Collateral Vault allowing the DCA to liquidate BTC once the Maturity Time is reached. In this case, all collateral is sent directly to the DCA for liquidation.

Liquidation Flow

The liquidation flow involves selling liquidated assets to recover as much of the loan value as possible. The DCA plays a critical role in mitigating risks for Liquidity Providers during liquidation.

The DCA performs the following tasks:

1. Receives Liquidated Assets: When a liquidation is triggered, the DCA takes custody of the liquidated assets.

2. Auctioning Collateral: The Lending Contract lists the collateral for auction at a discounted price from the current market value. If the collateral remains unsold, the discount increases by 1% every 10 minutes until a buyer is found. This ensures the collateral is sold quickly, minimizing the DCA’s custody risk.

3. Repaying the Pool: The auction proceeds, along with a liquidity penalty, are sent to the Lending Contract to cover the principal and interest.

4. Surplus or Deficit: If there is a surplus from the auction, it is returned to the borrower to minimize the impact of liquidation. However, if the auction proceeds are insufficient to cover the loan principal, the liquidity providers incur the loss.