Understanding the Liquidation Threshold
LTV (Loan to Value)
LTV is based on the values set in Davos smart contracts and is defined by Davos. It defines the maximum amount to be borrowed with a specific collateral. At the current LTV = .66, for every 1 rETH/wstETH/MATIC/etc worth of collateral, users will be able to borrow up to 0.66 rETH/wstETH/MATIC/etc worth of funds. For example, for 10 units of collateral each worth $2, which makes up $20 total, the user will be able to borrow up to
_user_deposit_ \* _liquidation_ratio_ = 20 \* 0.66 = $13.2 — up to 13 DUSD.
We recommend users to borrow under the LTV value to avoid a risk of passing the liquidation threshold.
Liquidation Threshold
The protocol also defines a liquidation threshold a.k.a. liquidation ratio. This threshold is calculated as 0.66 of the initial price of collateral when it was deposited by the user.
For example, if the user deposited 10 units of collateral when each unit was worth $2, which makes up $20 total, the liquidation threshold would be user_deposit_ \* _liquidation_ratio_ = 20 \* 0.66 = $13.2.
If the price of user's collateral went down, for example, to $1.8 per unit, then the unit price with safety margin would be _current_price_of_collateral_unit \* _liquidation_ratio_ = 1.8 \* 0.66 = $1.188 and the total worth of collateral would be _price_of_colatteral_with_safety_margin_ \* _amount_of_collateral_ = 1.188 \* 10 = $11.88. $11.88 would pass over the liquidation threshold of $13.2 _borrowed_amount_ - _current_worth_of_colateral_ = 13 - 11.88 = $1.12, which is >$0, which would be a clear trigger for a liquidation event through a Dutch auction.
Why Use Liquidation Threshold
The loan liquidation mechanism that Davos Protocol implements ensures that if the TVL of the user’s collateral ever falls below the amount of DUSD the user withdraws then their position will be liquidated. This ensures that the protocol without-fail is over-collateralized and fully backed by accepted LSTs.
You can track if any of your positions are close to being liquidated in the web app under the Liquidation section of the navigation bar.
Liquidation Model In Detail
The liquidation mechanism is applied to ensure that DUSD remains fully backed by accepted LSTs as collateral. When the price of your collateral goes under a certain value, the liquidation process may be triggered and your collateral may be sold in a Dutch auction.
The liquidation model is best described by the following example (correct for both Polygon and Ethereum):
| Step/Variable | Value |
|---|---|
| Price of 1 unit of collateral | $2 |
| Liquidation ratio | 66% |
| Price of collateral with liquidation ratio | $1.32 |
| User deposits 10 units of collateral | 10 * 2 = $20 |
| Borrow limit | user_deposit * liquidation_ratio = 20 * 0.66 = $13.2 |
| User borrows $13 of DUSD | 13 DUSD |
| Price of 1 unit of collateral decreases and now is | $1.8 |
| Collateral unit price, with safety margin | _current_price_of_collateral_unit * liquidation_ratio = 1.8 * 0.66 = $1.188 |
| Current worth of collateral, with safety margin | price_of_colatteral_with_safety_margin * amount_of_collateral = 1.188 * 10 = $11.88 |
| Trigger for liquidation | borrowed_amount - current_worth_of_colateral = 13 - 11.88 = $1.12, which is >$0 |
| Somebody starts a Dutch auction to liquidate the collateral. Starter is sent tip + chip as a reward for it, from Davos reserves | 5 + (14.69 * 0) = $5 |
| User collateral that goes to Dutch auction | 10 units |
| Liquidation penalty (fixed by Davos governance) | 13% of the debt |
| Debt to cover in the auction | borrowed_amount * liquidation_penalty = 13 * 1.13 = $14.69 |
| buf (percentage similar to liquidation penalty, fixed by the Davos governance) | 10% |
| top (start auction price of 1 unit of collateral) | current_price_of_collateral_unit * buf = 1.8 + (1.8 * 0.18) = $2.124 |
| Auction starts and price gradually decreases. Anybody can come and buy any amount of the liquidated collateral | |
| tau (time in seconds until price is 0; fixed by Davos governance) | 21600 |
| dur (time in seconds elapsed since the auction start; fixed by Davos governance) | e.g. 600 |
| Linear decrease of price of 1 unit of collateral | top * ((tau - dur) / tau) = 2.124 * ((21600 - 600) / 21600) = $2.065 after 600s of the auction |
| Somebody restarts the auction based on: — tail (specific amount of time elapsed; fixed by Davos governance) OR — cusp (% of price drop; fixed by Davos governance) | — — 40% of top = 1.98 * 0.40 = $0.792 |
| tip (flat fee given as a reward to auction starter/restarter; fixed by Davos governance) | 5 DUSD |
| chip (dynamic fee given as a reward to auction starter/restarter; fixed by Davos governance) | 0 |
| Restarter is sent tip + chip as a reward, from Davos reserves | 5 + (14.69 * 0) = $5 |