Liquidation Process

The liquidation process in Folks Finance ensures the stability and security of the protocol by managing under-collateralized loans. This process involves third parties who liquidate these loans, receiving incentives for maintaining protocol health.

Key Concepts

1. Triggering Liquidation:

   • Liquidation occurs when the total borrowed amount exceeds the borrowable amount.

   • Formula: $TB(t) > BA(t)$

   • Where:

     • $TB(t)$ is the total borrowed amount at time t.

     • $BA(t)$ is the borrowable amount at time t.

2. Liquidation Bonus:

   • Liquidators receive a bonus for repaying the under-collateralized position.

   • Example: A liquidation bonus of 10% means that if $50 is repaid, $55 worth of collateral is seized.

   • Formula:

   • Where:

     • $x$ is the amount of the borrowed asset being repaid.

     • $BtoC_t(x)$ is the conversion formula from borrow to collateral.

     • is the liquidation bonus percentage.

3. Borrow to Collateral Conversion (BtoC):

   • Converts the amount of borrowed assets to the amount of collateral seized.

   • Formula: $BtoC_t(x) = x \times \frac{P_{BOR}}{P_{COL}}$

   • Where:

     • $P_{BOR}$ is the price of the borrowed asset.

     • $P_{COL}$ is the price of the collateral asset.

4. Liquidation Fees:

   • A portion of the liquidation bonus is retained by the protocol as revenue.

   • Example: With a liquidation fee of 20%, if the collateral seized is $55, the protocol retains $1 as revenue.

   • Formula:

   • Where:

     • $L_t^R$ is the liquidation fee retained by the protocol.

     • is the bonus portion of the collateral seized.

     • is the liquidation fee percentage.

5. Remaining Collateral:

   • The remaining collateral after the liquidation fee is retained by the liquidator.

   • Formula:

   • Where:

     • $L_t$ is the remaining collateral retained by the liquidator.

Detailed Steps in Liquidation Process

1. Identifying Under-Collateralization:

   • The protocol continuously monitors loans to identify when the total borrowed amount $TB$ exceeds the borrowable amount $BA$.

   • Once identified, the loan becomes eligible for liquidation by third parties.

2. Executing Liquidation:

   • A third party, referred to as the liquidator, selects a specific borrow to repay and a specific collateral to seize.

   • The liquidator repays the amount $X$ of the borrowed asset and receives the corresponding collateral, plus the liquidation bonus.

   • Formula:

3. Incentivizing Liquidation:

   • To incentivize third parties to perform liquidations, they receive a bonus on the collateral seized.

   • The liquidation bonus ensures that liquidators are compensated for maintaining the health of the protocol.

4. Calculating and Distributing Liquidation Fees:

   • A portion of the collateral seized as a bonus is retained by the protocol as a liquidation fee.

   • Formula:

   • The remaining collateral after deducting the liquidation fee is kept by the liquidator.

5. Post-Liquidation:

   • The liquidator retains the net collateral after fees.

   • Formula: