Liquidations
Everything about liquidations, and how the Insurance Pool mechanism works
Last updated
Everything about liquidations, and how the Insurance Pool mechanism works
Last updated
A liquidation event occurs when a borrower's Health Factor drops to 1, indicating eligibility for liquidation. This process allows liquidators to seize control of the borrower's collateral, sell it, and utilize the proceeds to repay the outstanding debt while earning a liquidation fee.
Liquidations are crucial to Tren Finance as they maintain the protocol's solvency and ensure the stability of its collateral-backed synthetic dollar, XY. When a borrower's position becomes under-collateralized due to market fluctuations or asset depreciation, liquidations act as a safeguard by reclaiming and selling the collateral to cover the outstanding debt. This process prevents systemic risks and protects lenders by ensuring that all XY in circulation remains fully backed by sufficient collateral. Moreover, liquidations incentivize borrowers to maintain healthy collateralization ratios, thereby promoting responsible borrowing and lending practices within the platform. Ultimately, liquidations uphold the integrity and reliability of Tren Finance, fostering trust and stability in the decentralized finance ecosystem.
Tren Finance currently employs a full-collateral liquidation approach. When a position is flagged for liquidation, the borrower's entire collateral is seized to settle their borrowing position. After the liquidation event, the liquidated borrower retains only the amount of XY they initially borrowed.
The Insurance Pool is used to absorb the liquidation, utilizing a liquidity backstop of XY provided by insurance providers. This mechanism allows insurance providers to use their XY to acquire discounted collateral.
Regularly monitor the health factor of your TrenBox to ensure it remains well above 1.00. Maintaining a higher health factor provides a buffer against market volatility and price fluctuations of the collateral asset.
If the value of your collateral decreases or you have borrowed close to the maximum allowed amount, consider adding more collateral to your TrenBox. This will increase your collateralization ratio and reduce the likelihood of liquidation.
Additionally, repaying a portion of the borrowed XY can improve your health factor. This is particularly useful if the value of your collateral has decreased and you are near the liquidation threshold.
Liquidations are triggered when a TrenBox's Loan-to-Value (LTV) surpasses the Liquidation Threshold (LT) of the module. This can happen due to a decrease in the value of the collateral or an increase in the debt XY.
Anyone can trigger a liquidation by calling the liquidation function on the TrenBox that is under-collateralized.
The liquidation of TrenBoxes is connected with certain gas costs that the initiator must cover. The cost per TrenBox was reduced by implementing batch liquidations of up to 25 TrenBoxes but to ensure that liquidations remain profitable even in times of soaring gas prices the protocol offers a gas compensation given by the following formula:
f.g.; gas compensation = 300 XY + 0.5% of TrenBox's collateral
The 300 XY is funded by a Liquidation Reserve that users deposit into when opening their TrenBox. The 0.5% part comes from the liquidated collateral, slightly reducing the liquidation gain for Insurance Providers.
The Insurance Pool is the primary mechanism for handling liquidations. It holds XY deposited by users (Insurance Providers) and uses this XY to repay the debt of liquidated TrenBoxes. When a TrenBox is liquidated, the Insurance Pool burns an amount of XY equal to the TrenBox debt and receives the collateral in return.
When a TrenBox is liquidated, the following steps occur:
Debt Repayment: An amount of XY equal to the debt of the liquidated TrenBox is burned from the Insurance Pool.
Collateral Transfer: The entire collateral of the liquidated TrenBox is transferred to the Insurance Pool.
Insurance Providers in the Insurance Pool lose a pro-rata share of their XY deposits corresponding to the amount of debt repaid.
In exchange, they receive a pro-rata share of the liquidated collateral at a discount. Insurance Providers are required to claim the liquidated collateral.
Insurance Providers earn profits from liquidating collateral discounted to the market value.
Liquidation profits are inversely related to the LTV of the collateral type being liquidated. For instance, when an Asset A TrenBox with a 90% LT is liquidated, users can acquire Asset A at approximately a 10% discount.
Similarly, for an Asset B TrenBox that allows users to borrow XY at up to 80% LT, Insurance Providers can obtain Asset B at roughly a 20% discount upon liquidation.
As liquidations occur just above a predefined LT, you will most likely experience a net gain whenever a TrenBox is liquidated.
For example, suppose there is a total of 1,000,000 XY in the Insurance Pool and your deposit is 100,000 XY, representing 10% of the pool.
If a TrenBox with a debt of 200,000 XY and collateral of 400 Asset A is liquidated at a price of $545 (resulting in an LTV of 91%), your deposit will decrease by 10% of the liquidated debt (20,000 XY), from 100,000 to 80,000 XY. In return, you will gain 10% of the liquidated collateral, which is 40 Asset A worth $21,800. Your net gain from the liquidation would be $1,800.
Generally, you can withdraw your deposit from the Insurance Pool at any time, with no minimum lockup duration. However, withdrawals are temporarily suspended when there are liquidatable TrenBoxes with an LTV above the protocol-set amount that have not yet been liquidated.
While liquidations usually occur at an LTV well below 100%, it is theoretically possible for a TrenBox to be liquidated above 100% in a flash crash or due to an oracle failure. In such cases, the collateral gain might be smaller than the reduction of your deposit, resulting in a loss.
Additionally there is a risk that the value of the collateral is lower than the amount of XY used to liquidate the position due to further price decline
If XY is trading above $1, liquidations may become unprofitable for Insurance Providers even at an LTV below 100%. However, this loss is hypothetical since XY is expected to return to its peg, meaning the “loss” only materializes if you withdraw your deposit and sell XY above $1.
Redistribution serves as a backup mechanism to handle liquidations when the Insurance Pool is empty. It ensures that the protocol remains solvent by distributing the debt and collateral of under-collateralized TrenBoxes among all active TrenBoxes proportionally. This mechanism maintains the stability and reliability of the protocol, protecting user funds and encouraging responsible management of collateralized debt positions.
When redistribution occurs, the debt and collateral of the under-collateralized TrenBox are distributed among all remaining active TrenBoxes in the system. This redistribution is done proportionally based on the collateral amount of each active TrenBox
Redistribution ensures that the protocol can handle under-collateralized positions even when the Insurance Pool is depleted, maintaining overall solvency.
Assume there are three active TrenBoxes in the system:
TrenBox A: 10,000 XY debt, 20 Asset A collateral
TrenBox B: 20,000 XY debt, 40 Asset A collateral
TrenBox C: 30,000 XY debt, 60 Asset A collateral
Liquidation Event:
TrenBox D, with 15,000 XY debt and 30 Asset A collateral, becomes under-collateralized, and the Insurance Pool is empty.
Redistribution Process:
The 15,000 XY debt and 30 Asset A collateral from TrenBox D are redistributed among the remaining active TrenBoxes (A, B, and C).
The total collateral in the system before redistribution is 120 Asset A (20 + 40 + 60).
Proportional Distribution:
TrenBox A’s share of the total collateral is 20/120 = 1/6
TrenBox B’s share is 40/120 = 1/3
TrenBox C’s share is 60/120 = 1/2
Debt and Collateral Allocation:
TrenBox A receives 1/6 of 15,000 XY debt and 30 Asset A collateral:
New debt: 10,000 + 2,500 = 12,500 XY
New collateral: 20 + 5 = 25 Asset A
TrenBox B receives 1/3 of 15,000 XY debt and 30 Asset A collateral:
New debt: 20,000 + 5,000 = 25,000 XY
New collateral: 40 + 10 = 50 Asset A
TrenBox C receives 1/2 of 15,000 XY debt and 30 Asset A collateral:
New debt: 30,000 + 7,500 = 37,500 XY
New collateral: 60 + 15 = 75 Asset A
