WENWEN Protocol Liquidation Mechanism
WENWEN Protocol beta test on Barnard TestNet has been launched for almost a month now. We are thrilled to see many people participate in our beta test, and we have received much great feedback for our bounty program. I believe most of our testers already have a good understanding of our borrowing, farming, and staking functions. However, before we launch on the Starcoin mainnet, you should take a minute to understand our liquidation mechanism and how it works.
What is liquidation?
Liquidation is the process of converting one crypto asset for its equivalent amount of another crypto asset. In plain words, it is like selling assets for cash. Forced liquidation happens when you are borrowing with leverage and you are unable to fulfill your borrowing requirements for your leveraged positions. When you fail to maintain your leverage position, assets deposited in your leveraged position will be sold to repay your debt.
What is the liquidation process in WENWEN Protocol?
The liquidation process is triggered once the position’s collateral asset price falls to the liquidation price. During the liquidation process, a liquidator will execute the liquidation by paying the amount of WEN debt in exchange for the ownership of the equivalent value of the collateral asset. The borrower of this liquidated position keeps the amount of WEN borrowed. However, the borrower loses the amount of collateral asset deposited.
When you open a position and borrow some WEN, you will be able to set your liquidation price and position health according to your risk appetite. It is important for you to keep a close eye on your liquidation price and position health to avoid liquidation.
Here are some terms of liquidation you should understand before you start borrowing:
Maximum Collateral Ratio/ Loan to Value (LTV)
The Maximum Collater Ratio or Loan to Value (LTV) ratio defines the maximum amount of WEN that can be borrowed with the collateral asset. It’s expressed in percentage.
For example: When the Maximum Collateral Ratio is 70% for the STC borrowing pool, for every 1 STC worth of the STC deposited, borrowers will be able to borrow 0.70 STC worth of WEN.
The liquidation threshold is the percentage at which a position is defined as undercollateralized and flagged for liquidation.
For example, a Liquidation threshold of 80% for the STC borrowing pool means that if the value rises above 80% of the collateral, the position is undercollateralized and could be liquidated.
The delta between the Loan-To-Value and the Liquidation Threshold is a safety cushion for borrowers.
The liquidation price is the price of the collateral asset that will trigger the liquidation. When the price of the collateral asset drops to the liquidation price, the position will be liquidated.
For example, when you open a position in the STC borrowing pool. The current price of STC is $1, and your liquidation price is $0.5. When the price of STC drops to $0.5, your position will be flagged for liquidation.
A position will only be liquidated when it falls to the liquidation price. Borrowers need to maintain their position collateral price above the liquidation price to avoid liquidation.
Sufficient incentives are needed for the liquidators to execute liquidation in adverse market conditions.
The liquidation fee is the incentive fee given to the liquidators performing liquidation. From the borrower’s perspective, the liquidation fee is already included in the calculations when quoting a liquidation price for the respective collateral assets. The position will be liquidated when the borrower’s liquidation price is reached. From the liquidator’s perspective, the liquidation fee is the discount a liquidator gets when buying collateral flagged for liquidation.
This indicator shows the safety of a position. Borrowers can decide whether the position setting suits your risk appetite. When the position health indicates danger, this position is more likely to be liquidated compared to a position that shows safe.
Why the liquidation mechanism is important?
Leveraged positions are prone to volatile price swings, which may cause a borrower’s position to plunge into negative balance almost instantaneously. To ensure the soundness of the entire stablecoin supply, every WEN borrowed is fully backed by collateral assets. When a borrower fails to maintain their position above the liquidation price, the position will be liquidated to ensure the overall soundness of the protocol and other users.
Can I be a liquidator?
Yes! Anybody can liquidate a position as soon as it drops to the liquidation price. Liquidators can choose to repay the WEN debt. In return, the liquidators will receive the equivalent amount of collateral assets deposited in this position.
How can I avoid my position getting liquidated?
To avoid liquidation, you can increase your position health by depositing more collateral assets or repaying part of your debt.
You should beware of your position health and liquidation price and adjust them according to your risk appetite when opening your position. Also, it’s essential always to keep monitoring your position health to avoid liquidation.
Can you give me an example of liquidation?
Here is an example for you:
If Alice deposits 100 STC and borrows 50 STC worth of WEN.
When Alice opens this position, the current price of STC is $1, and the liquidation price for this position is $0.5.
When the market price of STC drops to $0.5, Alice’s position will be flagged for liquidation.
A liquidator can repay the amount of WEN debt in Alice’s position, including the amount of WEN borrowed, borrow fee, and accrued interest= 50 WEN + borrow fee + accrued interest. In return, the liquidator will receive the ownership of the equivalent value of the collateral asset at a discount rate.
After the liquidation, Alice will be able to keep her 50 WEN. However, she will lose ownership of her STC.
Our Beta test and bounty program are still ongoing, join us today to experience WENWEN Protocol before we launch on the Starcoin mainnet, and win airdrop rewards!
Beta Test: https://wenwen.money/
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