Liquidations

This page will give readers a better understanding of liquidations at abracadabra.money

LIQUIDATIONS

Abracadabra’s $MIM token is a non-algorithmic, collateral-backed stablecoin. This means that every $1 of $MIM should have more than $1 of collateral backing. The value of the collateral will fluctuate with changes in the market, so, like most other DeFi lending protocols, Abracadabra uses liquidations to ensure that $MIM remains overcollateralized.

Liquidation is a process that occurs when a position’s collateral value does not properly cover the position’s borrowed amount. Each cauldron will have different liquidation thresholds as defined by the Maximum Collateral Ratio. Once a Collateralized Debt Position (CDP) reaches that liquidation threshold, it becomes eligible for liquidation and anyone can repay a position in exchange for a portion of the collateral.

It is important to note that Abracadabra is an isolated lending protocol, which means that each CDP is treated independently. If a user has multiple CDPs, then each will have separate liquidation eligibility parameters, separate liquidation processes, etc.

To read more about isolated lending markets and why they are different from traditional lending protocols, please refer here.

Definitions

Collateral Ratio: Calculated as $MIM Borrowed / Value of Collateral. This is a representation of the current health of the loan. A low collateral ratio means that there is more collateral backing the $MIM borrowed.

Maximum Collateral Ratio: This is a parameter that is set on a per-cauldron basis. Once a CDP’s collateral ratio exceeds the maximum collateral ratio, the position becomes eligible for liquidation.

Liquidation Fee: This is the bonus amount of collateral that a liquidator gets to keep for liquidating a CDP. This fee is compensation for risks that the liquidator may be taking (e.g., slippage, high gas fees, etc.). This fee is deducted directly from the borrower’s collateral.

Hypothetical Example

Merlin has 2000 of xToken and each xToken is currently worth $1. The xToken cauldron has a Maximum Collateral Ratio (MCR) of 50%, which means that if Merlin deposits $2000 of xToken collateral, he can borrow up to $1000 of $MIM. Merlin decides to borrow $500 $MIM which he uses to buy ink to write his magic spellbook.

Zoltac the Liquidator watches Merlin’s CDP and is ready to liquidate at a moment's notice.

As fate would have it, the price of xToken drops from $1 to $0.4995 and Merlin’s 2000 xToken is now only worth $999. Merlin’s new collateral ratio is $500/$999 = 50.1%, which is just above the maximum collateral ratio of 50%. As such, Merlin’s CDP becomes eligible for liquidation, and Zoltac can step in to repay the debt.

Zoltac swaps $500 of $USDT for $500 of $MIM on Curve. He then pays off Merlin’s CDP in exchange for a portion of Merlin’s collateral. Given that the liquidation fee is 5%, Zoltac gets to keep $500 of xToken (1000 xToken) plus a 5% bonus (50 xToken) for keeping the $MIM safe. Altogether, Zoltac earns 1050 xTokens, which, at a price of $0.4995, is equivalent to $525. After subtracting Zoltac’s original investment of $500, we see that Zoltac earned $25 of profit.

When Merlin checks the Abracadabra UI, he will see that he no longer has 2000 xToken, but instead has 950 xToken left. Merlin gets to keep these 950 xToken and no longer needs to repay the original $500 of $MIM that he borrowed.

Liquidation Fees for Staked SPELL Holders

Staked SPELL holders automatically benefit from liquidations that happen on the platform. Of the liquidation fee that Zoltan collects, 10% of this goes back to Abracadabra and is set aside for staked SPELL holders. This would mean that 10% of the $37.50 of xToken ($3.75) is kept by Abracadabra and distributed to stakers.