Understanding the Liquidation Threshold

Collateral Ratio

Collateral ratio is based on the values set in Davos smart contracts and is defined by Davos. It defines the bar when a liquidation even should happen and is slightly above the max possible borrow.

The collateral ratio is:

• For vUSC and vUSDT — 93% of the deposited collateral value.

• For every other supported token — 66% of the deposited collateral value.

At the current collateral ratio = .66, for each unit of the supported collateral (except vUSDT, vUSDT), users will be able to borrow up to 0.66 worth of DUSD. 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.

The collateral ratio is:

• For vUSC and vUSDT — 93% of the deposited collateral value.

• For every other supported token — 66% of the deposited collateral value.

We recommend users to borrow way under the ratio to avoid a risk of loan liquidation.

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
chop (liquidation penalty; fixed by Davos governance)	10% of the debt
Debt to cover in the auction	borrowed_amount * liquidation_penalty = 13 * 1.13 = $14.69
buf (percentage added to the price of collateral at the start/reset of the Dutch auction, 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)	— no tail is currently used — 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