Liquidations
To provide better guarantees that Money Protocol’s stablecoin supply is fully backed by BTC collateral, Vaults whose Minimum Collateral Ratio falls below 110% are considered undercollateralized and subject to liquidation.
Anyone can trigger a liquidation, which can involve multiple Vaults being liquidated in one batch. This can be done by either specifying a set of Vaults or in ascending order starting from the Vault with the lowest collateral ratio. The latter approach is more resilient against race conditions that may occur in case of multiple simultaneous liquidations, while the former allows for the quick liquidation of large Vaults.
In most cases, Stability Providers and/or high-collateral Vaults will have the financial incentive to trigger liquidations as fast as possible. Money Protocol compensates for the gas costs of a liquidation, even when gas prices increase, by paying the reserved 200 BPD plus 0.5% of the Vault’s collateral (denominated in BTC) to the liquidator.
Money Protocol makes use of a liquidation mechanism that comprises two steps, which are executed in the following priority sequence:
- First, any undercollateralized Vaults are offset against the Stability Pool.
- Second, if the Stability Pool doesn’t have enough funds to cover the liquidated amount(s), any remaining undercollateralized Vaults are redistributed among other borrowers.
Liquidating Vaults against the Stability Pool
The Stability Pool is funded by Stability Providers who deposit BPD tokens into the stability pool contract. Its primary function is to serve as a buffer for liquidations - by absorbing liquidated BPD debts, with depositors receiving rewards for their contributions.
If the value of BTC drops and a Vault becomes undercollateralized (collateral ratio <110%), the system can offset the BPD debt immediately against an equal amount of pooled BPD tokens, which are then burned. As part of this process, the system transfers 99.5% of the BTC collateral from the liquidated Vault to the Stability Pool, while the remaining 0.5% is paid out to the liquidator.
Over time, the BTC will replace the BPD tokens in the Stability Pool. Whenever a liquidation takes place, the pool usually benefits from a collateral surplus gain since the collateral is generally worth more in USD than the burned BPD tokens. This is because liquidation occurs when the collateral ratio is below 110%, but the probability of it being significantly above 100% is very high - that is unless BTC drops by over 9.09% between two price feed updates.
Stability Providers are entitled to a portion of the liquidations that occur during their BPD deposit period. When the collateral is obtained, the combined value of the remaining BPD deposit and the BTC gain is very likely to exceed the previous deposit value. As a result, Stability Providers are encouraged by this prospect of positive returns.
The amount of surplus gains an individual receives depends on the ratio of their remaining BPD deposit (after past liquidations have been deducted) to the total BPD in the pool. If no new deposits are made, the individual shares will remain constant throughout the liquidations. However, if new deposits are made, earlier depositors are motivated to top up their deposits to maintain their share of future rewards.
Redistribution to other borrowers of liquidated Vaults
The Stability Pool may not hold enough BPD tokens to cover all the undercollateralized Vaults, or a Vault’s debt might only be partially covered due to depletion of the BPD in the Stability Pool during liquidation. In such a scenario, the system reassigns the outstanding debt and collateral from the partly liquidated Vault and other undercollateralized Vaults to all active positions.
The redistributed amount of collateral and debt is proportionate to the collateral amount held in the recipient Vault. Vaults that are highly collateralized will receive a greater share of debt and collateral from liquidated positions compared to those with lower levels of collateralization. This mechanism ensures that the system does not trigger successive liquidations.
Borrowers usually benefit from obtaining collateral and debt shares, which typically leads to a net gain. However, redistribution at the same time lowers their own collateral ratios. The possibility of being drawn down and ending up undercollateralized as a recipient during redistribution is low, and only impacts Vaults that are already extremely close to the Minimum Collateral Ratio, such as 111%.