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: ${collateral.seized}= BtoC_t(x) \times (1 + {liq.bonus})$

   • Where:

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

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

     • ${liq.bonus}$ 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: $L_t^R = {collateral.seized.as.bonus} \times {liq.fee}$

   • Where:

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

     • ${collateral.seized.as.bonus}$ is the bonus portion of the collateral seized.

     • ${liq.fee}$ is the liquidation fee percentage.

5. Remaining Collateral:

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

   • Formula: $L_t = {collateral.seized} - L_t^R$

   • Where:

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

Liquidations from Spoke Chains

Liquidations from Spoke Chains often fail due to asynchronicity in price updates and the limitation that only one liquidator can act at a time. In Folks Finance, liquidations are instead processed on the Hub Chain. Rather than requiring the liquidator to repay the borrow directly from the Spoke Chain, the debt and seized collateral are transferred to them on the Hub Chain, ensuring smoother execution without the need for token recovery in case of failure.

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: ${collateral.seized} = BtoC_t(x) \times (1 + {liq.bonus})$
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: $L_t^R = {collateral.seized.as.bonus} \times {liq.fee}$
   • 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: $L_t = {collateral.seized}- L_t^R$