Credit and Liquidations

Learn about credit limits and how to avoid liquidation

Understanding Credit Limit

The "Credit Limit" refers to the maximum amount of funds that can be borrowed based on the collateral provided. You can find this metric displayed on the "Portfolio" page, as shown below.

"Credit Limit" is calculated using the formula:

โˆ‘User Market Total Supplied in USD * Collateral Factor

The Collateral Factor represents the maximum percentage of collateral value that can be borrowed.

Example

  • User deposits $1000 of USDC to the protocol as collateral.

  • The collateral factor of USDC is 60%.

  • Calculate the "Credit Limit"

Credit Limit = โˆ‘User Market Total Supplied in USD * Collateral Factor

Credit Limit = $1000 * 0.6 = $600

  • Therefore, in this example, the credit limit of $600. This means you can borrow up to $600.

Understanding Credit Remaining

"Credit Remaining" refers to the amount of credit or funds that are available for a user to borrow. You can find this metric displayed on the "Portfolio" and "Borrow" pages, as shown below.

A higher "Credit Remaining" indicates a healthier collateral ratio and a safer margin against potential liquidation. Conversely, a lower "Credit Remaining" suggests a higher risk of liquidation. The risk of liquidation becomes significant when the "Credit Remaining" drops to a value of $0 or 0%.

The value of "Credit Remaining" is calculated using the formula:

(โˆ‘User Market Total Supplied in USD * Collateral Factor) - User Total Borrowed in USD

Example

  • User deposits $1000 of USDC to the protocol as collateral.

  • The user borrows $100 of USDC

  • The collateral factor of USDC is 60%.

  • Step 1: Calculate the "Credit Limit"

Credit Limit = โˆ‘User Market Total Supplied in USD * Collateral Factor

Credit Limit = $1000 * 0.6 = $600

  • Step 2: Calculate the value of "Credit Remaining"

Credit Remaining = Credit Limit - User Total Borrowed in USD

Credit Remaining = $600 - $100 = $500

  • In this example, when the user borrowed $100 of USDC, their "Credit Remaining" decreased to $500. If the remaining credit drops to a value of $0, the user's position becomes vulnerable to liquidation.

The percentage of "Credit Remaining" is calculated using the formula:

[(โˆ‘User Market Total Supplied in USD * Collateral Factor) - User Total Borrowed in USD] / (โˆ‘User Market Total Supplied in USD * Collateral Factor)

Example

  • User deposits $1000 of USDC to the protocol as collateral.

  • The user borrows $100 of USDC

  • The collateral factor of USDC is 60%.

  • Step 1: Calculate the "Credit Limit"

Credit Limit = โˆ‘User Market Total Supplied in USD * Collateral Factor

Credit Limit = $1000 * 0.6 = $600

  • Step 2: Calculate the percentage of "Credit Remaining"

Credit Remaining = [Credit Limit - User Total Borrowed in USD] / (Credit Limit)

Credit Remaining = [$600 - $100] / ($600) = 83.3%

  • In this example, when the user borrowed $100 of USDC, their "Credit Remaining" decreased to a percentage of 83.3%. If the "Credit Remaining" drops to 0%, the user's position becomes vulnerable to liquidation.

Avoiding Liquidation

Liquidation is the process of selling assets that have been used as collateral to repay a debt when a borrower fails to meet their loan obligations.

To minimize the risk of liquidation, borrowers should regularly monitor their "Credit Remaining." It is crucial to ensure that the "Credit Remaining" is greater than a value of $0 and remains above 0%.

This can be achieved by:

  • Loan Repayments: Loan repayments helps to maintain a positive credit remaining, thus reducing the risk of liquidation.

  • Supplying Additional Collateral: Supplying additional collateral increases the credit limit and amount of credit remaining, thus reducing the risk of liquidation.

Liquidators play a crucial role in the lending and borrowing ecosystem by facilitating the liquidation process. They actively monitor and identify undercollateralized loan positions. When a loan becomes undercollateralized, either due to decreased collateral value or increased borrowed amount, liquidators step in to protect depositors and potentially profit themselves.

Liquidators are incentivized to perform liquidations and contribute to the protocol's solvency through a Liquidation Incentive. This incentive consists of two components:

โ€ข 7% Liquidator Bonus: Liquidators receive this incentive for successfully executing liquidations and contributing to the protocol's efficiency.

โ€ข 3% Reserve Allocation: A portion of the incentive is allocated to the protocol reserves.

Factors Affecting Credit

Several factors determine the credit remaining of a borrower. These factors include:

  1. Borrowed Amount

The amount borrowed directly impacts the remaining credit of the borrower. As the borrowed amount increases, the credit remaining decreases. Borrowers should carefully assess their risk tolerance and borrowing needs to determine the appropriate loan amount.

  1. Market Volatility

The value of collateral assets can be influenced by market volatility, thereby impacting the amount of credit available. When determining the ideal credit amount, borrowers should take into account market conditions and their potential impact on collateral values.

  1. Changes in Collateral Value

The value of the provided collateral can directly impact the amount of credit available. Fluctuations in collateral value can either increase or decrease the available credit. Borrowers should be aware of these fluctuations and adjust their borrowing activities accordingly.

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