Liquidation
Introduction
Liquidation occurs when a borrower’s collateral value falls below the required threshold to secure their loan. This can happen due to a decrease in the collateral’s value or an increase in the value of the borrowed asset.
Before diving into how the liquidation mechanism works in Scallop, it’s essential to understand the key concepts behind liquidation on the platform. Scallop’s approach is designed to minimize the impact on borrowers while ensuring the protocol’s stability through efficient, precise, and user-friendly liquidation processes.
Soft Liquidation
Unlike other protocols, where a user’s position becomes unhealthy and liquidators working with the protocol automatically sell all of the user’s collateral to repay the borrower’s debt, Scallop takes a more user-friendly approach.
In Scallop, liquidators only sell the necessary amount of collateral to cover the user’s debt that exceeds the threshold. This ensures the user’s position returns to a healthy state. If the position still remains unhealthy even after partial repayment, the liquidation process will continue incrementally until the user’s position is fully restored to a healthy status.
This approach minimizes the impact on users, preserving as much of their collateral as possible while maintaining the integrity of the lending protocol.
Risk Level
Risk Level acts as a threshold indicator. A Risk Level below 100% means the borrower’s position is safe, while a Risk Level of 100% or higher signals that the borrower’s debt has exceeded the safe limit, triggering the possibility of liquidation to protect the protocol’s stability. This metric provides a clear and actionable way for users to monitor their borrowing status and manage risks effectively.
So, you might be curious about how Scallop calculates the value of this Risk Level. This is how we calculate the risk level :
Borrower's Collateral
USDC
$1
1000
90%
SUI
$1
500
80%
Borrower's Current Debt
SCA
$0.5
1000
100%
USDT
$1
500
100%
This example demonstrates how Scallop calculates the risk level.
Liquidation parameter
Here are the key liquidation parameters applied to borrowers undergoing liquidation on Scallop:
Liquidation Penalty
When a borrower’s position falls below the required health threshold, part of their collateral may be sold through liquidation. During this process, a liquidation penalty is applied to the value of the collateral. This penalty represents the total cost incurred by the borrower and is divided between the liquidator’s reward and the protocol reserve.
For example, if the liquidation penalty is 10%, then for every $100 of collateral liquidated, only $90 will be used to repay the borrower’s debt. The remaining $10 represents the liquidation cost, which is further distributed according to the reward and reserve factor settings.
Liquidation Reseve Factor
The Liquidation Reserve Factor represents the portion of the liquidation penalty directed to Scallop’s treasury. It ensures the protocol continues to grow a safety buffer for future risks.
Continuing the previous example, if the liquidation penalty is 10% and the liquidation reward is 5%, the remaining 5% of the penalty goes to Scallop’s treasury as the Liquidation Reserve Factor.
Liquidation Reward
To encourage participation in the liquidation process, Scallop offers a liquidation reward to users who repay unhealthy loans and acquire collateral. The reward allows the liquidator to purchase the borrower’s collateral at a discount from its market value.
For instance, if the liquidation reward is 5%, the liquidator can buy $100 worth of collateral by paying $95, effectively gaining a 5% discount. This incentive ensures that under-collateralized positions are quickly and efficiently liquidated, maintaining overall protocol stability.
Liquidation Factor
The liquidation factor sets a threshold for how much debt a user can take against their collateral.
Liquidation Scenario
In a hypothetical scenario, Kris provided $10,000 in USDC as collateral and borrowed $8,500 worth of SUI (with a collateral factor of 85% for USDC). If the value of SUI increases by 6% in a short period, reaching approximately $9,010, the risk level (debt amount / collateral * liquidation factor) rises from 94.4% ($8,500 / $10,000 * 90%) to 100.1% ($9,010 / $10,000 * 90%). At this point, Kris's account will trigger soft liquidation to reduce the risk level back to 100%.
In this liquidation event, the liquidator repaid approximately 11% of the borrower’s SUI debt, amounting to $1,000, reducing the debt to $8,010. A total of $1,100 in USDC collateral was liquidated, which included debt repayment, a liquidation reserve (5%), and a liquidation reward (5%).
After the liquidation, Kris was left with $8,900 in USDC ($10,000 - $1,100) and $8,010 in outstanding SUI debt ($9,010 - $1,000). On the other hand, the liquidator paid $1,000 worth of SUI and received $1,050 in USDC, earning a profit of $50.
Due to the liquidation, Kris’s liquidation threshold (risk level) decreased from 100.1% to 100%. If the price of SUI rises again, further liquidations will continue to be triggered to maintain the risk level at 100%.
Liquidation Guidelines
Under specific circumstances, liquidation will occur when a borrower's risk level exceeds 100% due to insufficient deposit or collateral value to cover their loan. This situation arises when the value of deposited collateral decreases or the borrowed debt value increases relative to each other.
To avoid liquidation, it is crucial to maintain awareness of your risk level and ensure sufficient margin in your account. If your risk level rises unexpectedly, you can mitigate it by increasing your collateral assets or repaying your loan. Additionally, you can use our integrated feature which will give your notification when your risk level already exceeds certain level. You can read this page How to Avoid Liquidation to get guide setup the notification.
Scallop’s soft liquidation mechanism aims to ensure that lenders are protected even if the value of the collateral decreases. It also provides an opportunity for borrowers to rectify the situation before their collateral is fully liquidated, minimizing their losses.
It's important to note that the specific details of Scallop’s liquidation mechanism may be subject to change or updates. It's always recommended to follow up with the latest announcement on the changes of the protocol.
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